AUG
25, 2015, 07.27 PM
Ray Dalio, the
founder of $160 billion hedge fund behemoth Bridgewater Associates, thinks the Federal Reserve is
going to do another round of quantitative easing.
Wall Street had
expected the Fed will raise rates at its September 17 FOMC meeting. Some now expect it
to wait until December given the wild market moves of the past few days.
Dalio though thinks
the Fed will head in a different direction altogether.
On Monday, he sent
a note to clients entitled "The Dangerous Long Bias and the End of the
Supercycle and Why We Believe That the Next Big Fed Move Will Be to Ease (Via
QE) Rather Than to Tighten."
It might seem like
a bold call, but given what has happened in global equities in the last week anything seems possible.
Business Insider obtained a copy of
the email, and has reached out to Bridgewater for comment.
Here is Dalio:
As you know, the Fed and our
templates for how the economic machine works are quite different so our views
about what is happening and what should be done are quite different.
To us the economy works like a
perpetual motion machine in which short-term interest rates are kept below the
returns of other asset classes and the returns of other asset classes are more
volatile (because they have longer duration) than cash. That relationship
exists because a) central banks want interest rates to be lower than the
returns that those who are borrowing to invest can generate from that borrowing
in order to make their activities profitable and b) longer-term assets have
more duration that makes them more volatile than cash, which is perceived as
risk, and investors will demand higher returns for riskier assets.
Given that, let's now imagine how the
machine works to affect debt, asset prices, and economic activity.
Because short-term interest rates are
normally below the rates of return of longer-term assets, you'd expect people
to borrow at the short-term interest rate and buy long-term assets to profit
from the spread. That is what they do. These long-term assets might be
businesses, the assets that make these businesses work well, equities, etc.
People also borrow for consumption. Borrowing to buy is tempting because, over
the short term, one can have more without a penalty and, because of the
borrowing and buying, the assets bought tend to go up, which rewards the
leveraged borrower. That fuels asset price appreciation and most economic
activity. It also leads to the building of leveraged long positions.
Of course, if short-term interest
rates were always lower than the returns of other asset classes (i.e., the
spreads were always positive), everyone would run out and borrow cash and own
higher returning assets to the maximum degree possible. So there are occasional
"bad" periods when that is not the case, at which time both people
with leveraged long positions and the economy do badly. Central banks typically
determine when these bad periods occur, just as they determine when the good
periods occur, by affecting the spreads. Typically they narrow the spreads (by
raising interest rates) when the growth in demand is growing faster than the
growth in capacity to satisfy it and the amount of unused capacity (e.g., the
GDP gap) is tight (which they do to curtail inflation), and they widen the
spreads when the opposite configuration exists, which causes cycles. That's
what the Fed is now thinking of doing-i.e., raising interest rates based on how
central banks classically manage the classic cycle. In our opinion, that is
because they are paying too much attention to that cycle and not enough
attention to secular forces.
As a result of these short-term
(typically 5 to 8 year) expansions punctuated by years of less contraction,
this leveraged long bias, along with asset prices and economic activity,
increases in several steps forward for each step backwards. We call each step
forward the expansion phase of each short-term debt cycle (or the expansion
phase of each business cycle) and we call each step back the contraction phase
of each short-term debt cycle (or the recession phase of the business cycle).
In other words, because there are a few steps forward for every one step back,
a long-term debt cycle results. Debts rise relative to incomes until they can't
rise any more.
Interest rate declines help to extend
the process because lower interest rates a) cause asset prices to rise because
they lower the discount rate that future cash flows are discounted at, thus
raising the present value of these assets, b) make it more affordable to
borrow, and c) reduce the interest costs of servicing debt. For example, since
1981, every cyclical peak and every cyclical low in interest rates was lower
than the one before it until short-term interest rates hit 0%, at which time credit
growth couldn't be increased by lowering interest rates so central banks
printed money and bought bonds, leading the sellers of those bonds to use the
cash they received to buy assets that had higher expected returns, which drove
those asset prices up and drove their expected returns down to levels that left
the spreads relatively low.
That's where we find ourselves
now-i.e., interest rates around the world are at or near 0%, spreads are
relatively narrow (because asset prices have been pushed up) and debt levels
are high. As a result, the ability of central banks to ease is limited, at a
time when the risks are more on the downside than the upside and most people
have a dangerous long bias. Said differently, the risks of the world being at or near the end of its
long-term debt cycle are significant.
That is what we are most focused on.
We believe that is more important than the cyclical influences that the Fed is
apparently paying more attention to.
While we don't know if we have just
passed the key turning point, we think that it should now be apparent that the risks of deflationary
contractions are increasing relative to the risks of inflationary expansion
because of these secular forces. These long-term debt cycle forces are clearly
having big effects on China, oil producers, and emerging countries which are
overly indebted in dollars and holding a huge amount of dollar assets-at the
same time as the world is holding large leveraged long positions.
While, in our opinion, the Fed has
over-emphasized the importance of the "cyclical" (i.e., the
short-term debt/business cycle) and underweighted the importance of the
"secular" (i.e., the long-term debt/supercycle), they will react to
what happens. Our risk is that they could be so committed to their highly
advertised tightening path that it will be difficult for them to change to a
significantly easier path if that should be required.
Bridgewater’s
Ray Dalio clarifies prediction that Fed will roll out new QE
Published: Aug 26, 2015 5:19 p.m. ET
Ray Dalio, founder of Bridgewater Associates LP, on Tuesday created a
stir on Wall Street by predicting that the next move by the Federal Reserve
will be to ease the monetary policy rather than tighten as is widely
anticipated.
Read: Bridgewater’s Ray Dalio sees Fed launching quantitative-easing
measures
The head of the world’s largest hedge fund later elaborated on his
stance:
“We are not saying that we don’t believe that there will be a tightening
before there is an easing. We are saying that we believe that there will be a
big easing before a big tightening,” he said in an updated post on his LinkedIn
account. “We don’t consider a 25-50 basis point tightening to be a big
tightening. Rather, it would be tied with the smallest tightening ever.”
He shared a table which showed that the average tightening over the past
100 years was 4.4% and pointed out that the smallest was 0.5% in 1936, the same
year that the U. S. was undergoing a deleveraging of the long term debt cycle.
“To be clear, while we might see a tiny tightening akin to what was
experienced in 1936, we doubt that we will see anything much larger before we
see a major easing via QE,” he wrote.
Dalio also pointed out that since 1981, every cyclical peak and cyclical
low in interest rates were lower than previous points until short-term interest
rates eventually dropped to 0%, which prevented a further rate cut. In
response, central banks launched quantitative-easing programs to boost growth
amid strong secular disinflationary forces.
“We believe those secular forces remain in place and that pattern will
persist,” said Dalio.
Dalio’s argument for quantitative easing flies in the face of consensus
given that the Federal Reserve has indicated an interest-rate increase is in
the offing although the timing of such a move is uncertain given the recent
stock-market volatility..
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