Risk Asset Markets Susceptible to Corrections, Crypto Has Grown in Importance and Complexity, says ECB VP

More persistent inflationary pressures could push nominal yields higher, which may put valuations of assets under pressure, wrote Luis de Guindos.

In the Financial Stability Review, November 2021, Luis de Guindos, the Vice-President of the European Central Bank, talked about equity and risky asset markets being susceptible to corrections.

While markets for risky assets maintaining their striking buoyancy makes them more susceptible to drawdowns, at the same time, Euro area housing markets continue to expand rapidly, “with little indication that lending standards are tightening in response,” he wrote.

The combination of historically low real yields and elevated valuations has bonds vulnerable to growth shocks and adverse interest rates, it added.

“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 normalisation.”

Additionally, the valuation of assets can come under pressure by an increase in nominal yields due to more persistent inflationary pressures than are currently anticipated.

In the report, Guindos said cryptocurrencies remain subject to volatility, with the growing popularity of stablecoins increasing interlinkages between crypto and financial markets.

The review noted that the market capitalization of stablecoins has risen from $5 billion to $120 billion since 2020 but still only accounts for around 6% of the estimated $2 trillion total crypto market cap.

However, interlinkages between stablecoins and crypto imply a correlation of risks between these market segments.

At the same time, stablecoins “are serving increasingly different functions in the crypto-asset ecosystem,” he wrote.

Besides acting as a relatively safe “parking space” for crypto volatility, stablecoins also serve as a bridge between crypto and fiat currencies. Due to their relatively low price volatility, he said that stablecoins are being progressively used for trading and as collateral in crypto derivative transactions or decentralized finance (DeFi).

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