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Trading  | July 4, 2017

High valuations and low volatility don’t reflect the level of economic growth nor the geopolitical uncertainty facing the market, the Autorité des Marchés Financiers says in a mid-year report on main risks to global markets. While stock markets have shown resiliency, the French regulator warns of the “systemic threat” fromn a “sharp market correction.”

As AMF continuesEquity market volatility therefore now appears to be decorrelated from political uncertainty indexes

Confirming Deutsche Bank’s perspective of market complacency.

This trend, combined as we have already seen with high valuations on some equity markets, especially in the US

And extremely low spreads on the bond markets, raises questions as to whether the risks affecting the financial markets are being underestimated, which may lead to a brutal repricing of assets.

Aside from equity markets, AMF points to three other concerns…

  • Risk of a sharp increase in interest rates amid rising private debt and low risk premiums. In this environment, the European Central Bank’s policy will have a decisive impact on the euro area. Some emerging countries may find the cost of debt unsustainable in the event of a substantial increase in long-term interest rates or domestic currency depreciation (because their debt is denominated in foreign currencies);
  • Risk of regulatory competition and reduced international cooperation, with voting results (US elections, UK Brexit vote) opening up a period of uncertainty that financial markets do not appear to have priced in. The supervision, recovery and resolution of central counterparties (CCPs) represent a key issue in this regard, insofar as counterparty risk is now largely concentrated with CCPs;
  • Cyber-risk in a persistently uncertain geopolitical environment.

The isolated corrections we have seen, accompanied by temporary spikes in volatility, are understandable if the markets continue to be dominated by expansionist monetary policy conducive to supporting them. However, a return to the norm is well under way in the United States, and if this trend continues could prove destabilizing without a backdrop of fundamental support for valuations.

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