With the world barely through the worst of an unprecedented crisis, central bankers are already wondering if the next one is around the corner.
From Washington to Frankfurt, what began months ago as a murmur of concern has morphed into a chorus as officials ask if a risk-taking binge across multiple asset markets might presage a destabilizing rout that could derail the global recovery.
Just last week, the European Central Bank and the Bank of Canada cited mounting threats, cognizant of the retrenchment that ensued during the 2008 financial crisis. Meanwhile Bitcoin’s dramatic swings after a warning about cryptocurrencies from the People’s Bank of China showcased how sensitive some markets have become.
Pessimists at global monetary institutions can find bubbles almost anywhere they look, from equities to real estate, while officials such as Federal Reserve chief Jerome Powell argue any threats remain contained.
Central banks bear some responsibility for financial-market fervor after huge doses of stimulus and liquidity injections to keep economies afloat. The resulting buoyancy is at least partly a euphoria effect, applauding a snap back in growth whose scope can only be guessed at — with eventual repercussions judged to range from a benign boom to an inflationary spiral.
“Where we do see more exuberance is around growth expectations,” Max Kettner, a strategist at HSBC Holdings Plc, told Bloomberg Television. “Particularly in the U.S. they’ve been raised to an enormous degree. So that is, I think, the exuberance.”
Market speculation has led to heavy volatility of late, including wild girations and drops in Bitcoin from an all-time high above $60,000 in April. More traditional assets are struggling too, with rates on haven German bonds, for example, climbing around 50 basis points this year, closing in on breaking into positive territory for the first time in more than two years.
Kettner’s mention of “exuberance” followed the European Central Bank’s use of similar words on Wednesday, echoing former Fed Chairman Alan Greenspan’s 1996 observation of “irrational exuberance” before the dotcom bubble.
The euro-zone institution observed the threat of economic spillovers from, for example, a U.S. equity-market correction. Bank of Canada officials voiced similar concerns a day later, and highlighted the housing market as expectations of continuing price increases fuel purchases.
Three weeks earlier, a Fed policy meeting veered into a debate on stability, where participants observed “elevated” risk appetite and discussed dangers posed by hedge fund activity. In a subsequent report, they warned of “vulnerabilities” and “stretched valuations,” exacerbated by high corporate debt.
Meanwhile Bank of England Governor Andrew Bailey recently wondered aloud if speculation in stocks and Bitcoin might themselves be a “warning sign.” And a Norwegian official said that cryptocurrency volatility could threaten lenders if their exposures keep rising.
Central banks have had nagging concerns for a while. Already in January, ECB markets chief Isabel Schnabel told colleagues that stocks could become vulnerable to “more broad-based repricing.”
In China, with a recovery cycle more advanced than the U.S.’s, the top banking regulator revealed in March that he was “very worried” about bubbles, specifying “very dangerous” real-estate investing.
That might be partly what UBS AG Chief Executive Officer Ralph Hamers had in mind in late April with his own alarming view. Noting “bubbles in some asset classes,” including real estate, he told Bloomberg Television that “we are getting close to the peak of things.”
Some senior central bankers are trying to be sanguine despite flashing warning lights. After the Fed decision in April, Powell insisted that “the overall financial stability picture is mixed but on balance, it’s manageable.”
ECB Vice President Luis De Guindos — whose job includes preparing his institution’s threat assessment — dialed down from its worried tone last week by saying economic risks are “much more balanced than in the past.”
The difficulty for central banks is in managing the consequences for asset prices of their monetary policies, a challenge that has bedeviled them since the 2008 calamity. Periodically, that makes institutions such as the Fed the target of criticism.
“Central banks are desperately wanting to make sure, be certain,” said James Athey, investment director at Aberdeen Asset Management Plc. “It also means they keep policy way too easy for way too long.”
The alternative officials face is to dare to wind down stimulus, taking on the risk of choking an economic recovery with a corresponding cost to livelihoods.
Iceland took that plunge last week, delivering the first policy tightening in Western Europe with an interest-rate increase to contain inflation and a rampant housing market.
The larger euro area, whose constituent regions vary from some of the world’s most prosperous to examples of perennial malaise, can’t be so nimble. That’s why the ECB recommends “more targeted” fiscal support for companies while avoiding stimulus withdrawal.
Similarly, the Fed cited use of macroprudential tools as important to allow monetary policy to take its course. JPMorgan economists wrote this month that they anticipate Australia’s banking regulator will “formalize” debt and loan-to-income restrictions soon.
However central banks and financial regulators respond to ebullience, they know the stakes are as high as ever, with the need to cement a rebound from a severe crisis in a world which will struggle to tolerate another one.
At least officials can take comfort in recognizing a more familiar pre-pandemic environment: The last time their worries about risk were so synchronized was in November 2019, just weeks before the coronavirus began to cripple the global economy.
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