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“Exuberance,” often a polite term for reckless speculation, in cryptocurrency, housing, and junk bonds has left those markets vulnerable to dramatic reversals if interest rates rise sharply, the European Central Bank (ECB) warned in its twice-yearly financial stability report.
The Eurozone’s economy is well along in its recovery, which reduces short-term financial risks, the bank said.
However, current positive conditions “lure investors to make unwise bets on assets that risk losing value if and when interest rates rise against inflation, the ECB added.
“Concerns particularly relate to pockets of exuberance in credit, asset, and housing markets as well as higher debt levels in the corporate and public sectors,” the report said.
Inflation and the ECB’s continued negative interest rates have prodded investors to take greater risks in search of higher yields, leaving crypto, debt, and housing markets “increasingly susceptible to corrections,” the bank cautioned.
We at the Trends Journal have long said that rising interest rates will crash equity, bond, and housing markets, in articles such as “Forecast: Melt-Up, Crash-Down” (25 Aug 2020), “Higher Mortgage Rates Hobble Housing Market’s Expansion” (2 Mar 2021) and “Bond Market Tightens, Junk Bonds in Crisis” (24 Mar 2020).
“A correction in markets could be triggered by a weaker-than-expected economic recovery, spillovers from adverse developments in emerging market economies, a re-intensification of stress in the non-financial corporate sector, or abrupt adjustments in market expectations regarding the prospective path of monetary policy normalization,” the ECB report added.
Although Europe’s inflation rate struck a 10-year high of 4.1 percent in October, the bank has continued to insist that price rises will ease back below the bank’s 2-percent target rate over the next few years.
The ECB will not raise interest rates in 2022, bank officials again stated last week, sinking the euro’s value against the dollar and pound (see related story in this issue).
However, the report left the bank out for that pledge, citing “a risk that recent strains in global supply chains and the spike in energy prices could have longer-lasting effects on inflation than expected.”
The price of homes in the European Union rose 7.3 percent in this year’s second quarter, compared to a year earlier, the fastest rise since just before 2008’s Great Recession.
The ECB sees “growing signs of over-valuation” that has left housing in many parts of Europe “prone to a correction,” in part because of a “deterioration in lending standards.”
Crypto and other “more exotic market segments also remain subject to speculative bouts of volatility,” while non-bank financial firms continue “to face elevated credit risk” because of heavy investments in junk bonds, according to the bank.
The ECB admitted that its own policies, such as negative interest rates, have contributed to reckless speculation.
However, it insisted that curbing the risks could best be done by regulators and not by the bank “leaning into the wind” by raising interest rates now.
TRENDPOST: New COVID War mandates and lockdown in many European nations which will drag down economic growth will help persuade the ECB to keep rates low even as inflation continues well above its 2-percent target.