ECB Warns of Major Downside Risk As Stock Market Goes ‘Out of Sync’ With Geopolitical Uncertainty

The European Central Bank (ECB) is warning that the past month’s stock market recovery is at risk amid ongoing geopolitical uncertainty.

In a forward to the bank’s biannual “Financial Stability Review,” ECB Vice President Luis de Guindos says markets are still “highly sensitive” to news about global trade arrangements.

“Financial market functioning held up well during the recent sell-off. Despite the drawdowns, equity valuations remain high while credit spreads still appear out of sync with underlying credit risk. Open-ended funds investing in corporate bonds have seen some outflows and do not appear well prepared to withstand significant liquidity stress. In the event of renewed turmoil, these funds may be forced to sell assets. This could turn price swings into more disorderly adjustments.”

The ECB warns that the European economy has “pronounced” vulnerabilities to a potential trade war due to its integration in global supply chains.

The bank also says it’s unclear if the Trump Administration is committed to international cooperation.

“While it is hard to predict the medium to long-term implications of these individual layers of uncertainty, they entail a broad risk of geoeconomic fragmentation across the globe, in turn raising the likelihood of increasingly frequent and impactful adverse tail events. Although the announcements of trade agreements between the United States and some of its trading partners point towards an easing of trade tensions, concerns remain that these tensions could escalate into a trade war with the potential for significant adverse impacts on global growth, inflation and asset prices.”

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