The European Central Bank (ECB) is cautioning investors about the risk of a sudden and significant market correction, noting that markets are underestimating multiple threats, including conflicts such as the situation in Iran. In its semi-annual Financial Stability Review released on Wednesday, the ECB stated that despite recent market adjustments, asset prices remain historically high, and downside risks related to geopolitical, fiscal, and macro-financial developments are being underappreciated by investors. "This leaves markets vulnerable to a significant repricing," said ECB Vice President Luis de Guindos. Having overseen financial stability across the 21 eurozone countries for eight years and set to step down this month, Guindos highlighted that non-bank financial institutions could amplify market volatility in the event of a downturn. This warning represents the ECB's latest signal that overly optimistic investors are causing a disconnect between financial markets and the real economy. Global stock markets continued their record-breaking rally on Wednesday, driven by gains in technology stocks, yet the high valuations of these tech companies are facing increasing scrutiny. The ECB is currently grappling with the ongoing energy supply shock, which Guindos reiterated could fuel inflation and pose downside risks to economic growth. Despite concerns about economic prospects, investors still anticipate an interest rate hike by the ECB next month. Guindos added that conflicts in the Middle East could further heighten market volatility, challenging debt repayment capabilities amid slowing growth and rising financing costs. The ECB is not alone in sounding alarms about market risks. Last month, Bank of England Deputy Governor Sarah Breeden remarked, "There are plenty of risks in the market, yet asset prices are at historical highs," predicting a market adjustment "at some point in the future." Since the outbreak of conflict, eurozone government bond yields have generally risen, reflecting increased pricing of term premiums and renewed inflation concerns. This trend is putting pressure on public finances across multiple countries, even as governments expand investments in infrastructure and defense. The ECB emphasized that the eurozone sovereign debt market is currently functioning in an "orderly manner," with spreads remaining low. However, it also noted that increased participation by price-sensitive investors such as hedge funds, along with concerns about fiscal sustainability in the U.S. and elsewhere, could trigger or amplify sudden repricing of risk assets. Against this backdrop, the ECB highlighted the growing importance of controlling domestic fiscal expenditures. It stated, "Any fiscal support measures should be temporary and targeted, avoiding persistent inflationary pressures and further straining public finances." The Frankfurt-based central bank also pointed out financial stability risks in the private credit sector, although European institutions currently have limited exposure. On Tuesday, it indicated that insurers and pension funds could be more severely impacted than banks in the event of losses.