Bridgewater warns US inflation fight is far from over

The investment chief at one of the world’s top hedge funds has warned the US battle with inflation is far from over, and bets on a rapid series of interest rate cuts from the Federal Reserve next year are premature.

The comments from Bob Prince, co-chief investment officer of Bridgewater Associates, pour cold water on this week’s global rally in stocks and bonds, which was sparked by relief at data showing annual US inflation had fallen to a more than two-year low of 3 per cent in June.

Prince at Bridgewater, which manages $125bn, said markets were wrong to assume the Fed will soon ease monetary policy. “The Fed is not going to cut,” he told the Financial Times. “They are not going to do what is priced in.”

Pricing in futures markets indicates that investors anticipate one further 0.25 percentage point rate rise from the Fed’s current target range of 5 to 5.25 per cent by the autumn. Over the following 12 months they expect the central bank to reverse course, cutting borrowing costs six times to around 3.8 per cent by November 2024.

Traders ramped up their bets on rate cuts after this week’s inflation figures. Although headline inflation fell sharply, core inflation — which excludes the volatile food and energy sectors and is very closely watched by the Fed — fell more slowly to 4.8 per cent. The core rate particularly remains far above the Fed’s stated goal of 2 per cent.

“Inflation has come down but it is still too high, and it is probably going to level out where it is — we’re likely to be stuck around this level of inflation,” Prince said. “The big risk right now is that you get a bounce in energy prices when wages are still strong”, which could drive a rebound in inflation, he added.

Prince, who oversees the Connecticut-based firm’s assets with co-CIOs Karen Karniol-Tambour and Greg Jensen, said he believes core inflation is likely to bottom out between 3.5 and 4 per cent, pushing the Fed to tighten monetary policy further and disappointing investors who this week sent US stocks to their highest level in over a year. 

That tightening “could take the form of holding rates steady in the face of expectations of a cut”, he said.

Expectations that the Fed will soon end its historic tightening cycle have helped drive market optimism all year. The two major US stock indices — the benchmark S&P 500 and the tech-heavy Nasdaq Composite — have pulled out of bear-market territory this year to rise 16.5 and 33 per cent respectively. The returns on bonds have been more muted, with the Bloomberg global aggregate index up 2.4 per cent this year, but investors have locked in some of the highest yields in decades on hopes that the Fed is near the end of its tightening.   

Even so, Prince said “it’s just not a good environment to be holding assets generally in bonds or stocks”, adding that cash is currently an attractive alternative.

He said Bridgewater had been “positioned for a tightening cycle”, which has meant taking a cautious stance on riskier asset classes.

“Our performance is close to flat this year. We were down some in early January and we’ve been gradually making it back since then.” He did not discuss specific performance figures on either of the firm’s two primary strategies: its Pure Alpha fund — a traditional macro fund — or its risk-parity All Weather fund.

The Fed will have to keep rates higher for longer because its inflation fight is stymied in part by a strong labour market, said Prince. Fiscal and monetary programmes in the early days of the Covid-19 pandemic helped build up household savings, but also tightened the labour market enough that wages rose meaningfully. That has meant that US consumers’ income has been higher, allowing them to continue absorbing price increases. 

“Current levels of spending are being financed by income, not a credit expansion,” Prince said. “So inflation is really hard to bring down.”