The US economy faces a looming deceleration as tighter monetary policy starts to weigh on activity and ratchets up pressure on financial markets, according to the world’s biggest hedge fund.
Bob Prince, co-chief investment officer at Bridgewater, believes the recent market turmoil was triggered by investors realising that this year’s strong economic growth and robust corporate earnings were likely peaking, as interest rates rise and the boost from tax cuts fades.
“A lot of optimism about future earnings growth has been baked into equity valuations. But we are at a potential inflection point where the economy is moving from hot to mediocre,” Mr Prince said in an interview.
Mr Prince, who manages Bridgewater’s $160bn of assets alongside founder Ray Dalio and co-CIO Greg Jensen, said: “We are now approaching the stage where monetary tightening could produce, perhaps not a big downturn, but more pressure.”
Treasury yields started climbing sharply earlier this month, as a string of healthy US economic data and hawkish comments by Federal Reserve officials forced investors to reassess their sanguine view of how far and how fast the central bank would be able to raise interest rates.
Although the bond market reversal was triggered by good economic news, the jump in Treasury yields was so abrupt that it last week spilled over into the US stock market, sending the S&P 500 tumbling by the most in more than half a year — a drop so severe it reverberated across global markets.
Most bourses regained their footing on Friday, and US Treasury yields have fallen from the seven-year highs they touched at the peak of the bond rout. But Mr Prince cautioned that more turbulence was likely, given how major central banks, led by the Fed, were turning the screws on monetary policy.
“This week could fade into history and we won’t remember it, but we are clearly shifting from an era of monetary easing to monetary tightening,” he said. “If that [a growth inflection point] is what is happening, then this won’t be a one-week event.”
Tax cuts have invigorated the US economy this year, pushing the jobless rate to its lowest since 1969, consumer confidence to its highest since 2000, and service sector activity to its greatest since 1997. Even the Fed now predicts that growth will surpass 3 per cent in 2018.
But that has led it to pencil in a fourth rate increase for the year in December, and another three in 2019, to cool the economy. At the same time, the Fed is shrinking its balance sheet of bonds acquired in the crisis.
President Donald Trump last week voiced his concerns about rising interest rates, saying the Fed was “out of control” and describing its current policies as “crazy”.
“I think they’re making a big mistake,” Mr Trump said.
With rates now expected to rise sooner than previously thought, growth forecasts for next year are more muted, and some analysts are even predicting another downturn by 2019 or 2020. Mr Prince said that the dangers were mitigated by the financial system’s improved resilience, but fretted about the implications of more limited monetary and fiscal firepower.
Swelling budget deficits limited the US government’s flexibility to stimulate the economy, and the Fed’s interest rates remain low. At the same time, the political resistance to a new dose of quantitative easing is likely to be severe, the hedge fund manager noted.
“The risks of a sharp downturn are somewhat mitigated by the fact that we’re not overleveraged, but the risks of a prolonged downturn are greater,” Mr Prince said. “What will pull us out of it?”