Harriet Rachel Reeves, the shadow Chancellor of the Exchequer, is eager to see more savers put their money into stocks and shares. To achieve that, she has brought forward inflation busting cuts to the limits on cash ISAs. We are taking this decision to energize capital movement into the grappling stock market. In fact, experts are projecting explosive growth in this market over the next five years. Equally, this growth is under a very real threat from the uptick in financial stability risks. A correction in firm valuations, as we’re already seeing in the AI-fueled startup boom, would endanger that growth.
Reeves’ budgetary reforms may be intended to misdirect investment habits, but recessionary signals are pointing towards a new focus on stock markets over cash savings. Retiring trillions of dollars in debt will help pay for expected sector growth. The good news is that a large part of this debt will be paid for by the AI companies in question. About half of this expansion will come from external actors, mostly through debt capital.
Just beneath the surface, worries are mounting about whether this expansion is sustainable. As the Bank of England recently cautioned, AI firms are increasingly getting connected with credit markets. As this interconnectedness continues to expand, it has the potential to exacerbate risks to financial stability. If there is a correction in asset prices, the resultant losses on lending could compound these risks.
“Deeper links between AI firms and credit markets, and increasing interconnections between those firms, mean that, should an asset price correction occur, losses on lending could increase financial stability risks,” – The Bank of England
There are a lot of parallels to previous market downturns when looking at the current environment. Share prices in the UK are hitting all-time highs. We are talking about valuations that are approaching highs not witnessed since the 2008 global financial crisis. Furthermore, equity valuations in the United States echo those observed before the dotcom bubble burst, raising alarms about potential market corrections.
Jamie Dimon, chief executive of JP Morgan, went so far as to say he was “most worried about where the market’s going.” Let me be very clear: I’m far more worried than anybody else is. He believes a major correction could be underway within the next few years.
The consequences of the current, dramatic rise in interest rates may change the landscape for existing mortgage-holders even more deeply. By 2028, nearly 3.9 million people—43% of all mortgage-holders—are expected to refinance at higher rates. For the average owner-occupier who’s leaving fixed rate shelter, we’d expect their monthly payment to increase by 8%. Most of this increase is due to the continued effect of higher interest rates. On the flip side, nearly a third of all owner-occupiers will save money over the next two years due to a decrease in their average monthly payments.
The most recent chips on interest rates mark a total drop of over 180 basis points (.0121) from a peak last year. Chancellor Reeves accepted the proposed changes but left out written provisions for additional preventive actions. Taken together, these measures would significantly decrease the monetary risks associated with the rapidly emerging situation.
The incredibly dynamic environment of AI and the funding structure underneath it creates concerns around long-term stability. Therefore, all stakeholders should continue to be watchful at the prospect of changes in market forces.