While the Federal Reserve is soliciting advice about how it should rejigger its approach to monetary policy, Bridgewater Associates founder Ray Dalio has a suggestion: Maybe the central bank should pay more attention to its "unofficial" third mandate.
At least since the appointment of Fed Chairman Alan Greenspan (the progenitor of the infamous "Greenspan put") in the late 1980s, the central bank has openly tailored policy to address its dual Congressional mandate: maintaining stable prices and maximizing employment.
But since the stock market started to wobble in late September, a new "executive mandate" has emerged, as President Trump has attacked Fed Chairman Jerome Powell for ruining his party by insisting on raising interest rates. As far as Trump understands, there's no good reason why the central bank couldn't wait another 2-6 years before taking away the punch bowl, so to speak. And as fate would have it, Dalio, who has expressed reservations about the president's behavior and policies, agrees, according to CNBC.
Before moving ahead with its plans to raise interest rates back to "neutral" (or beyond), the central bank should examine monetary policy's impact on asset prices, and maybe err on the side of caution. Because right now, the central bank is hurting asset prices. And also possibly Bridgewater's returns.
DALIO: Right now, the Fed expects to raise it one more time this year. And probably three – two or three times next year. I think there’s a problem in terms of asset prices. I think that rate of increase would not be able to be made because we’ve raised interest rates to a level where it’s hurting asset prices. We have now, a flat yield curve. We have -- in other words, the -- you can now get in a two to five-year note, you can get about 3%. And you have no price, no material price risk. So, we’re in a situation right now that the Fed, I think, will have to look at asset prices before they look at economic activity. It’s a difficult position because that stimulation that they have, in the form of those tax cuts, is a big stimulation into the capacity limitations as we have low slack. So that the economy itself will pressure them to raise rates. I think probably too much. I think we have a supply/demand problem for bonds that will particularly come next year and the year after. In other words, because of that tax cut and the deficits, we’ll have to sell a lot more bonds and United States itself can’t absorb that quantity of bonds. So we’re going to have to sell those bonds to investors in other countries. You look at the portfolio of those, and they have a lot of those that are sort of overweight in that bond. So I think there’s a supply/demand imbalance and a difficult position for the Federal Reserve. It’s a risky situation.
Given Powell's suggestion that interest rates are nowhere near neutral, and that the central bank intends to hike at least until we get there, Dalio isn't the only hedge fund titan urging the central bank to slow down (he's not even the only one speaking Thursday in Greenwich, where Paul Tudor Jones also highlighted the risks surrounding the one-two punch of the deficit expansion combined with rapid rate hikes).
But seeing as Thursday was a day that ended with "y", Dalio took care to remind his interviewers that, regardless of what the Fed does, we're already in the "seventh or eighth inning of the business" cycle, and that the US is facing risks that we haven't seen since the 1930s, like an "emerging power" (China) solidifying its position as our largest economic competitors.
DALIO: Well, you know, there’s the short-term debt cycle, long-term debt cycle and productivity. We’re in the late stages, maybe the seventh, the eighth inning of the business cycle, right? We’re in the part of the cycle where there’s been a lot of monetary easing. Central banks bought $15 trillion worth of assets, pushed them up a lot. We had the benefit of a corporate tax cut, all of that stimulation, and as a result, we’re in the late part of cycle where there’s a tightening of monetary policy. And you know, so it’s kind of the late part of the cycle with assets fully priced. And in terms of the longer-term debt cycle, we’re at a point where interest rates are comparatively low, the capacity of central banks to ease monetary policy is limited, United States is limited, and other counties it’s limited. So that’s where we ar. We’re in a position also where we have the emerging power China competing with the United States, an established power, as an effective power competitor. That’s very much like the late 1930s. So that’s where I think we are.
Probably since the interview was taking place just miles from the conglomerates former headquarters, Dalio's interlocutors couldn't resist asking for his thoughts on the credit-market story du jour: Whether or not GE's rapidly deteriorating investment-grade credits could become the first fallen angel to signal a broader collapse. But his hosts were disappointed: Try as they might, they couldn't goad Dalio into sounding the alarm on the junk bond market. Instead, Dalio said the real risks are bound up in CLOs and leveraged loans.
SORKIN: And, Ray, talking about bubbles, do you worry about high-yield bonds? We were having a conversation earlier today actually about General Electric, a Connecticut-based company whose debt has come under a lot of pressure of late.
KERNEN: Boston based.
SORKIN: Now Boston based, yeah.
DALIO: the -- a lot of the high-yield debt market has gone into leveraged loans and CLO. And so, as a result, it’s off balance sheet -- I mean, it’s private. And there are parts of that market more than the particular high yield debt market; although if I was to take double "b," some triple "b" types of debt, I think that it’s more than fully priced.
The interview concluded with Dalio offering a few choice pieces of advice for the state of Connecticut: As its capital city teeters on the verge of bankruptcy, the state would probably manage to attract investment if it created a "special economic zone" in downtown Hartford where companies would be free of any tax burden.
It could be a very effective economic development policy, he said.