The energy crisis set off by Donald Trump’s war in Iran has made a financial crash more likely, according to the Bank of England’s financial stability chief, who warned that private credit, sky-high sovereign debt and stock market exuberance posed salient threats to the global economy.
Sarah Breeden, the central bank’s deputy governor for financial stability, branded the closure of the vital Strait of Hormuz shipping lane “the worst energy shock in my living memory”, which had put more stress on the banking and financial system.
“Conflict in the Middle East continues to add to uncertainty and unpredictability, with sharp movements in energy prices and bond yields,” she told an event in Washington, before listing ballooning national debt, private markets and “stretched asset valuations” as exhibiting similar traits to previous financial crises.
Breeden said: “Across all three of these risks you can hear echoes of the past. The combination of leverage, complexity, concentrations and opacity rhyme with the vulnerabilities brought about by the rise of CDOs [a form of debt instrument] in 2007 and, more distantly, the development of investment trusts in 1920s.
“All at a time when the disconnect between high risky asset prices and real economy uncertainty seems marked.”
The Bank of England rate-setter’s warnings echo a report published earlier this week by the International Monetary Fund (IMF), which sounded the alarm on ballooning sovereign debt levels.
The financial body said countries’ unwillingness to rein in exorbitant borrowing has left them particularly exposed to any sudden changes to the interest rate outlook, as seen in the aftermath of the Iran war.
Bank of England monitoring private credit jitters
Breeden pointed to the increasing levels of leverage being used by hedge funds to buy up government bonds, warning the trend was likely to compound the ill-effects of a downturn in financial conditions.
“These strategies support liquidity in normal times,” she said. “But as price‑sensitive, leveraged investors, hedge funds can amplify shocks and cause jumps to illiquidity.”
Breeden, who after Bank of England governor Andrew Bailey is the most senior official to oversee financial stability in Britain, also raised concerns about collapsing sentiment in riskier debt markets, which she said was showing signs of “vulnerabilities”.
A flurry of corporate collapses linked to the private credit industry has sounded alarm bells over the underwiting of so-called shadowbanks, and might lead investors to loose confidence in the sector, the Bank official said.
“As history shows, stress often emerges first at the margins – and then spreads,” she told the Washington event,” she said.
“A broad-based credit crunch in private markets could tighten financing conditions for the UK real economy. If valuations or rating assessments are challenged – through defaults, markdowns or discovery that risk models have been mis-calibrated – lenders may pull back.”
The ballooning levels of debt being used to fund the artificial intelligence rollout could also spark a crash were there to be a “reassessment of the future earnings potential” of the technology,” she added.
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