The European Central Bank (ECB) stated in a report released on Wednesday that the situation in Iran and ongoing trade frictions could hinder economic growth in the eurozone, increase borrowing costs, and strain the ability of some member states to maintain fiscal balance.

Currently, financial markets are reacting mildly to the Iran conflict: stock valuations are high, corporate financing costs are low, and the yield spreads of government bonds across the eurozone's 21 member countries remain at low levels. There are concerns that investors may be underestimating potential risks as a result.

In its semi-annual Financial Stability Review, the ECB indicated that if energy shocks persist and economic growth slows significantly, markets may reassess the fiscal sustainability of various countries, potentially leading to sharp adjustments in government bond prices.

Significant fluctuations in bond prices could further raise corporate borrowing costs, creating a vicious cycle that ultimately threatens financial stability and impacts the real economy.

This risk is particularly pronounced at present, as governments are already raising funds for numerous emergency projects, significantly reducing fiscal buffers and limiting policy flexibility.

The ECB added that defense spending, green transition initiatives, and various fiscal measures aimed at mitigating the impact of rising energy costs on households and businesses have kept government bond financing demands high, further increasing medium-term fiscal pressures.

The growing involvement of hedge funds in the government bond market also heightens risks. The ECB noted that while these institutions can enhance market liquidity under normal conditions, their widespread use of high leverage makes asset prices more susceptible to sharp swings driven by market sentiment.

Furthermore, less transparent non-bank financial institutions could amplify bond sell-offs. These entities typically have weaker asset liquidity, higher leverage, and relatively lenient regulatory standards, while maintaining close ties with traditional banks. In the event of a crisis, risks could easily spread throughout the banking sector.

The ECB pointed out that the likelihood of various risks intertwining and amplifying each other is increasing, thereby intensifying challenges to financial stability.

The report also warned that concerns over U.S. debt sustainability could spill over into Europe. U.S. Treasury bonds have traditionally been considered global safe-haven assets, but if markets begin to question the credibility of U.S. fiscal policy, investor expectations could shift rapidly, triggering a global chain reaction.

The ECB further noted that markets have started to take notice of the increasing reliance on debt financing by companies related to artificial intelligence, a trend that warrants caution.