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Tighter Dollar Liquidity Exacerbates Pressure on Risk-parity Thesis

Xing, Victor (2018): Tighter Dollar Liquidity Exacerbates Pressure on Risk-parity Thesis.

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Abstract

Global monetary authorities remained steadfast in policy normalization to pare unconventional easing programs, as Federal Reserve’s balance sheet run-off and China’s BRI loans created a perfect storm in dollar liquidity tightening. There are signs that risk-parity funds are in the grip of a pincer movement, with rising reflationary pressure from globalization’s retreat and tighter dollar liquidity spur deleveraging flows and deny investors safe harbors from cross asset risk shedding; this can be seen in short-covering and flight-to-quality flows to long-maturity Treasuries, which increased bond funds' vulnerabilities to higher interest rates. Some investors view tighter financial conditions as signs of “policy error” after past decade’s policy easing, but BIS cautioned that FCIs’ sensitivity to equities may induce policymakers to place excess weight on stock valuations, overstate easy financial conditions’ benefits, and overlook the distributional effects of monetary accommodation.

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