European Central Bank board member Isabel Schnabel warned Thursday that a troubling gap has opened between record stock market valuations and the economic dangers posed by the Iran war and uncertain AI-driven gains, cautioning that investors may be underpricing the risks ahead.
A “Kind of Disconnect”
“There really seems to be a kind of disconnect,” Schnabel said at an event at the London School of Economics on May 7. “One could question whether markets are possibly a bit complacent here.”
Her remarks came as the S&P 500 and Nasdaq Composite notched fresh record closes earlier this week, driven by a surge in semiconductor and AI-related stocks. Intel and Advanced Micro Devices led gains, with the PHLX Semiconductor Index up 62% for the year.
Schnabel pointed to two sources of what she views as market overoptimism. First, she said investors appear to assume that damage to energy supply chains caused by the Iran conflict would be “rapidly reversed” — an outcome she considers unlikely. Second, she said expectations for productivity gains from artificial intelligence may be overly optimistic and not fully grounded in current fundamentals.
Inflation Risks Mount
The warning on stock valuations accompanied a broader message about inflation. In a separate speech Thursday on central bank independence, Schnabel said the ECB would need to raise interest rates “if the energy price shock broadens,” adding that “this risk has increased in recent weeks.”
Surveys cited in her speech showed euro area consumers now expect inflation three years ahead to be 3% — a level not seen since the 2021-22 inflation surge — while signs of supply chain disruptions are re-emerging as the Iran war disrupts energy flows. The ECB left rates unchanged at its last meeting but signaled that the rise in energy prices since U.S. and Israeli attacks on Iran in late February would push inflation higher and slow growth.
Broader Concerns Over Financial Stability
Schnabel’s speech in London focused primarily on threats to central bank independence, identifying high government debt and financial deregulation as structural forces that could constrain monetary policy. She referenced former Federal Reserve Chair Jerome Powell’s warning at his final press conference about “legal attacks” on the Fed.
On financial markets more broadly, she flagged that hedge funds now account for more than a third of trading in U.S. Treasuries and even higher shares in euro area sovereign bonds, making demand for government debt “less reliable.” She also noted vulnerabilities in private credit markets, though she said the sector remained too small in Europe to pose systemic risk.
