After years of risk aversion, sentiment switched to a “risk on” mode. Did financial markets enter a new phase of “irrational exuberance”? Such a verdict is certainly debatable. But financial markets are at least anticipating significant further improvements in economic fundamentals and prospects. And they are anticipating that governments around the world will continue to implement the necessary reforms.
These expectations create vast scope for confidence shocks. This, in turn, interacts in an unfavourable way with another risk arising from a prolonged period of low interest rates. A prolonged period of low interest rates could set the wrong incentives. It could encourage banks to postpone necessary balance sheet adjustments.