A leading investor in the world’s largest hedge fund has warned that high inflation is here to stay and central banks may be powerless to fight it without derailing the economic recovery, after a week in which soaring inflation energy prices rocked markets around the world.
Bob Prince, co-chief investment officer at Bridgewater Associates, said the Federal Reserve’s claim that the current explosion in inflation will prove to be transitory is likely to be disputed. Price pressures will be difficult to correct, he said, as they result from a shortage of much-needed resources as the global economy rebounds from pandemic lockdowns.
“If there’s inflation, the Fed is in a box because tightening won’t do much to reduce inflation unless it does a lot, because that’s determined by ‘offer. And if they do a lot, it brings the financial markets down, which they probably don’t want to do, ”he told the Financial Times.
“Decide between the lesser of two evils, what do you choose? I think you most likely choose inflation because there isn’t much you can do about it anyway. “
Prince’s comments echo an increase in inflationary anxiety in the markets this week, as intense competition for natural gas supplies has spiked fuel prices, stoking fears of rising prices. wider price and triggering a fall in bond prices, which are sensitive to inflation. The 10-year US Treasury yield, which rises as prices fall, hit a four-month high of 1.60% on Friday as measures of market-based inflation expectations hit their highs levels since May.
The movements were even more marked in Europe, where the gas crisis is more acute. Germany’s ten-year break-even inflation rates – a measure of investors’ inflation expectations over the next decade – hit their highest level since 2013 at 1.68%, taking yields to unprecedented levels since May. In the UK, where the Bank of England has said it could raise interest rates as early as this year in an effort to bring inflation under control, 10-year break-even points are at their highest level since 2008 and Gilts yields climbed 1.14% on Friday, the most since May 2019.
Prince described the BoE’s rate warning last month as a “wake-up call” to investors. However, he suggested central banks also needed to adapt to their limited ability to retaliate.
“We’re in this situation where you still have this inertia of demand, it pushes against the limited supply and that has driven up inflation,” he said. “And while the consensus is that this will be very transient and rebound right away, we don’t think so, because there is a lot of inertia of these spending to continue and it just won’t be that easy to resolve these constraints. supply, especially since Covid remains a problem. ”
The comments represent a departure from Prince’s perspective in June, when he downplayed comparisons between the present and the “big inflation” of the 1970s.
“It’s starting to look a bit like the 1970s and the oil shocks,” he said this week. He explained that in the 1970s, oil prices rose due to OPEC supply cuts, pushing inflation up. This dynamic caused the economy to fall while pushing up inflation. “Raising interest rates will not increase the supply of oil.”
Despite the latest massive bond selloff and a pullback in stocks over the past month, many investors are sticking to their view that much of the current round of price hikes will prove to be temporary, and central bankers will keep their cool unless they get more convincing. evidence of broader demand-driven inflation.
“Central banks should respond to inflationary pressures if demand consistently exceeds supply,” said Gurpreet Gill, fixed income strategist at Goldman Sachs Asset Management. “Today they are in isolated areas. We expect to come out of this crisis on a higher inflation path, but that’s not a throwback to the 1970s, when you had double-digit inflation.
Others argue that the specter of stagflation – a combination of rapid price hikes and slowing growth – is keeping bond markets under control. A sharp rise in the cost of living could quickly become a brake on growth and even fuel fears of a recession, believes Luca Paolini, chief strategist at Pictet Asset Management. In this environment, one would expect central banks to keep rates low – or cancel any premature hikes – making long-term government bonds more attractive and limiting any sell-off.
“Inflation is like a tax that kills demand,” Paolini said. “In a sense, if it gets too bad, it kills itself – but that’s not a positive scenario.”