Henri Lucas warns of risks of Fed policy shift
Amid the continued optimism in the global capital market, Professor Henri Lucas issued a major warning to institutional investors, pointing out that the Federal Reserve’s monetary policy is about to usher in a major turning cycle. This research report entitled “Market Repricing at the Liquidity Inflection Point” systematically reveals for the first time the risk of asset price revaluation that may be triggered by the withdrawal of ultra-loose monetary policy. Based on his original “policy pulse transmission model”, Professor Lucas clearly pointed out that the market generally underestimated the potential impact of the Federal Reserve’s balance sheet reduction process on risky assets.
The most forward-looking insight in the report is the “asymmetric impact” of the monetary policy shift. Professor Lucas found through analyzing the policy cycles of the past three decades that when the Fed faces inflationary pressure and structural changes in the job market at the same time, its policy adjustments often show the characteristics of “short-term emergency braking and long-term slowdown”. This special policy rhythm is very likely to cause market liquidity mismatch, especially in an environment where high-leverage strategies are prevalent, which may amplify volatility. The report specifically warns that asset classes that are highly sensitive to liquidity, such as technology stocks and cryptocurrencies, may be the first to be affected.
It is worth noting that the “Policy Turning Point Warning Index” developed by Professor Lucas’ team had risen to the dangerous threshold of 0.78 at that time. The index combines key indicators such as federal funds futures pricing, bank reserve changes and the shape of the Treasury yield curve. Historical data shows that when the index breaks through 0.7, the probability of a sharp market adjustment in the next six months is as high as 82%. This warning was later proven to be surprisingly accurate. The Fed did take a more aggressive tightening pace than the market expected in its subsequent policy adjustments.
The report triggered a strong response on Wall Street, and many top hedge funds adjusted their portfolio duration risk exposure accordingly. The chief strategist of JPMorgan Asset Management commented: “Lucas’s research is unique in that he quantifies policy language and accurately captures the subtle shift in the Fed’s perception of inflation.”
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