A warning issued by the European Central Bank (ECB) on Wednesday claimed that there can be “bouts of high volatility” in financial markets could result because of the increasing uncertainty about global economic growth,
The ECB has warned that there can be a further drop in asset prices because of a weaker than expected growth and a potential escalation of trade tensions, in its Financial Stability Review (FSR), which provides an appraisal of potential risks to stability in the euro area.
An acrimonious and escalating trade war between the United States and China has resulted in a number phases in the stock market where investors have chosen to engage in heavy selling. Since the start of this month, there was a drop of more than 4.6% and 4% respectively in the Dow Jones Industrial Average index and the S&P. And for the month of May, there was a fall of 5.2% in the pan-European Stoxx 600.
A full-blown trade war between the US and China would be “extremely detrimental,” said Luis de Guindos, vice president of the ECB, in a television interview and added that “it could affect not only the volatility of markets, it could affect the real economy quite rapidly.”
Any escalation of trade tensions would be “very negative news” for the global economy even as there is a slowdown in the global economy, he said.
The forecast of growth for 2019 was brought down to 1.1% from an earlier forecast of 1.7% made in December by the euro zone’s central bank in March. There had been a “sizable moderation in economic expansion that will extend into the current year”, ECB President Mario Draghi had said at the time.
The findings from the new report were “not actually a bad situation”, said Luke Hickmore, a senior investment director at Aberdeen Standard Investments.
“The ECB are doing exactly what you’d hope they’d do — they’re warning you about risks, but you’re getting well paid for a lot of those risks if you’re in credit markets,” he said, adding that within the credit landscape “there are lots of attractive opportunities around European banks, with a few risks.”
Particularly vulnerable to the weaker corporate earnings was the growing global leveraged loan sector, the report identified. . Leveraged loans are those forms of loans that are given to those companies or individuals who already carry a considerable amount of debt on them or they have a poor credit history. According to S&P, the market for leveraged loans in the US recently touched a value of $1 trillion.
Long-standing structural problems would be tackled by the banks through consolidation, De Guindos said. “Consolidation could be an instrument, not only domestic consolidation but also cross-border consolidation, could be an instrument in order to get rid of this excess capacity and to start to gain efficiency in terms of costs and in terms of profitability, but this is something that has to be implemented by the management of the banks,” he said.
(Adapted from CNBC.com)