Central bankers are sounding the alarm over heightened risks to global financial stability, citing a surge in retail investor participation in equity markets and the activities of highly leveraged hedge funds. The Bank of International Settlements (BIS), often referred to as the central bank for central banks, has issued a stark warning in its latest annual economic report. The BIS serves as a forum for central banks, fostering international monetary and financial cooperation and acting as a bank for central banks.
The 133-page report suggests a significant market correction, a 10 per cent fall from its recent peak, could trigger a wider economic downturn. This risk is amplified by growing retail investor exposure, particularly in the world’s largest economy, where household net worth in the sharemarket now exceeds dotcom-era levels. The BIS warned such a correction “could have larger macroeconomic consequences today than in the past,” potentially leading to a sharper consumption pullback. Retail investors’ enthusiastic engagement in the artificial intelligence (AI) trade since late 2022, and events like SpaceX’s float targeting individual investors, underscore this trend.
Central bankers are also concerned about highly leveraged hedge funds in the bond market, whose reliance on short-term “repo” borrowing creates risks of “fire sales” and destabilising deleveraging in response to shocks. The BIS drew parallels between the current AI investment surge and historical market manias like the 1830s canal mania or the dotcom boom. These past episodes, marked by breakthroughs attracting excessive capital, ended in investment reversals and recessions. With five major AI hyperscalers projected to invest over $US1 trillion into AI across 2023-2024, the warning coincides with increasing trader concerns about return on AI capital expenditure, with the PHLX semiconductor index recently dropping 5.3 per cent and SpaceX down 13.1 per cent.
