Equity leverage, AI, sovereign debt elevate stability risks

The FPC notes a substantial increase in the use of leverage in equity markets, particularly by hedge funds, creating risks for prime brokers and interconnected sovereign debt markets.

This trend is partly driven by a narrow set of AI-related stocks, increasing market concentration.

Rapid advances in frontier AI capabilities also present significant financial stability risks, primarily from cyber and operational vulnerabilities.

While AI offers productivity gains, its equity valuations are underpinned by highly uncertain long-term earnings forecasts.

A reassessment of these prospects could trigger a fall in equity prices, amplified by high concentration and leverage.

The FPC is monitoring the macrofinancial implications of AI developments, including increasing complexity and opacity in AI-related debt structures.

The conflict in the Middle East caused a substantial negative supply shock, leading to volatility in energy prices and sovereign bond yields, tightening global financial conditions.

While the signing of a Memorandum of Understanding has reduced near-term risks, substantial uncertainty and market volatility remain.

Persistent vulnerabilities in global sovereign debt markets, characterised by historically high issuance and rising debt-to-GDP ratios, could interact with these geopolitical developments.

Risky credit markets, including private credit, also remain vulnerable to tightening financing conditions, with elevated redemption requests in some retail funds highlighting liquidity and valuation concerns.

The FPC is particularly concerned about the simultaneous crystallisation of these interconnected vulnerabilities.