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Key Words: ‘Excessive risk-taking’ and ‘overvaluations’ are a dangerous side effect of monetary policy, says European Central Bank official

“‘By removing safe assets from financial markets, central bank asset purchases incentivise investors to rebalance their portfolios towards riskier and less liquid assets…Over time, however, as the outlook gradually improves, the portfolio rebalancing channel may at some point result in excessive risk-taking and overvaluations.’”

— Isabel Schnabel, ECB executive member

Those are Isabel Schnabel’s remarks on Wednesday, commenting on the negative effects of monetary policy in helping to create asset bubbles in financial markets.

The ECB estimates that the return on a basket of global financial assets is currently “far above its long-term average,” while the likelihood of a costly downturn in economic activity “has increased markedly over the medium term.”

Schnabel’s comments, which also suggested the ECB’s asset purchases increased moral hazard, was delivered as a part of the fifth annual conference of the European Systemic Risk Board. It comes as the Federal Reserve is set to hold its a monetary policy meeting on Dec. 14-15, with the pace of reduction of its asset purchases likely to be an issue for the rate-setting Federal Open Market Committee headed by Jerome Powell, who was last month nominated for a second term as Chairman.

Powell hasn’t been so vocal about the creation of asset bubbles, but the ECB executive’s remarks might likely be running in the back of the minds of the members of the U.S. central bank next week.

That is particularly as the 10-year Treasury notes
TMUBMUSD10Y,
1.516%
,
as well as stocks in the Dow Jones Industrial Average
DJIA,
+0.10%
,
the S&P 500 index
SPX,
+0.25%

and the Nasdaq Composite
COMP,
+0.43%
,
appear to be richly valued by some measures.

Financial markets have been on a roller-coaster ride given the uncertainty surrounding the omicron variant of the coronavirus that causes COVID-19, but it is Fed policy that may be more significant now.

Economists think Powel recently opened the door for the central bank to announce it is doubling of the monthly pace of asset purchases to $30 billion from $15 billion—consistent with quantitative easing ending in mid-March instead of mid-June.

For its part, the ECB next gathers on Dec. 16, a day after the Fed, and it may signal its desire to cut its monetary stimulus for Europe.

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