Risk of a 1970s-Style Inflation Shock is Rising, Warns Brevan Howard

The current macro environment is as complicated as at any time during the last 75 years, according to Brevan Howard.

Risk of a 1970s-Style Inflation Shock is Rising, Warns Brevan Howard
The office building at 55 Baker Street, housing the offices of Brevan Howard Asset Management LP, in London, U.K. (Photographer: Jason Alden/Bloomberg)

Global price rises risk turning into 1970s-style inflation shock, which eventually led to recession and high unemployment, according to hedge fund giant Brevan Howard Asset Management. 

The macro trading firm, which is off to one of its best gains in nearly two decades of trading, said the current macro environment is as complicated as at any time during the last 75 years, according to its annual outlook. 

“This combination of high inflation, tight labour markets, and uncertain inflation expectations introduces the prospect of a 1970’s style wage-price spiral which proved very costly to reverse during the Volcker Era,” according to the note to shareholders of a listed fund, which it manages.

Brevan Howard, one of the best-known macro hedge fund firms with about $19 billion in assets, invoked a period of crippling inflation decades ago when former Federal Reserve Chairman Paul Volcker delivered the so-called Saturday Night Special, a radical -- and unexpected -- tightening of monetary policy on an October weekend in 1979. Volcker’s tightening of monetary policy led to a recession and high unemployment but ultimately reined in spiraling inflation. 

Right now, the Fed is “significantly” behind the curve in raising rates, which should be between 4% to 6% based on traditional approaches to monetary policy, the firm said in a rare comment on the market outlook, adding that both risk assets and fixed income tend to underperform in such an environment. 

Brevan Howard echoes comments from veterans such as Man Group Plc’s Chief Executive Officer Luke Ellis and Henry Kaufman who have flagged the risks of spiraling inflation and questioned whether the Fed will do enough to combat it.

Read More: Man Group CEO Doubts Fed Has the Gumption to Tackle Inflation

Trading Profits

Brevan Howard had been positioning for the current macro landscape since last year and betting on higher rates. While such trades did not led to any major gains last year, they are turning into bumper profits for the firm in 2022. 

Its flagship Brevan Howard Master Fund, which managed $8.5 billion at the end of February, was up 6.6% this month through March 25, boosting gains this year to 9.25%, according to an investor letter. 

A spokesman for the Jersey, Channel Islands-based investment firm, declined to comment.

Macro hedge funds are seeing their fortunes turn after a decade of sub-par returns as central banks move to raise rates and inject market volatility. Firms such as Haidar Capital Management and Castle Hook Partners have been among some of the biggest winners in the industry this year. 

Brevan Howard said Russia’s war against Ukraine was unimaginable at the start of the year and will be inflationary and disrupt growth. While “aggressive” sanctions appear an appropriate response to Russia’s aggression, it is a stagflationary shock.  

“Although not a seamless comparison, there are similarities to the OPEC oil embargo in 1973 and the second oil shock following the Iranian revolution in 1979,” Brevan Howard said. “Meanwhile, the major central banks face a difficult balancing act.”

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