The Role of Fixed Income As Central Banks Pivot
The Fed’s shift to fighting inflation triggered a liquidity regime change. As a result, asset allocators face increased uncertainty from a variety of sources.
In this paper we will examine the current investment and monetary policy environment and discuss the use, and misuse, of asset allocation correlation matrices to determine effective portfolios. We will discuss the role of market liquidity, both within the context of historically easy monetary accommodation, along with the reduced broker/dealer role as a result of bank regulation which discourages balance sheet risk-taking. We will provide evidence that as the liquidity regime evolves, inter-asset correlations are also likely to change, creating greater uncertainty and increasing the importance of tail-risk management. Additionally, we will discuss the larger tool kit and a potential for an opportunistic overlay that investors may employ for superior long-term returns.
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