Bridgewater Sees Market Turmoil on ‘Aggressive’ Fed Tightening

(Bloomberg) -- Investors may be underestimating the need for “aggressive” monetary tightening from the Federal Reserve and other central banks to combat inflation, resulting in “significant risks” for markets, according to Bridgewater Associates.

Following hawkish comments from the Fed Chair Jerome Powell last week, investors have brought forward expectations of tightening, pricing in five quarter-point rate hikes this year. Further out, however, they're predicting fewer rate increases, anticipating the Fed will end the cycle with the policy rate at about 1.65% and long-term inflation expectations anchored around 2%. Consumer prices surged 7% in December from a year earlier, the fastest pace since 1982.

“The markets are discounting a smooth reversion to the prior decades' low level of inflation, without the need for aggressive policy action -- that it will mostly just naturally happen on its own,” the world's biggest hedge fund said in its 2022 outlook. “We see a coming clash between what is about to transpire and what is now being discounted.”

The “massive adrenaline shot of money and credit” during the pandemic has now produced a self-reinforcing cycle of high nominal spending and income growth that is unlikely to cool without aggressive monetary tightening, Bridgewater said.

“Because there is such a big difference between what is discounted and what we think is likely, we see the potential for large market moves, which of course implies significant risks from holding assets, as well as significant alpha opportunity from price change,” according to the report.

Bridgewater has “grown significantly less bullish” on financial assets versus cash across the developed world. In contrast, it finds Chinese assets attractive as Beijing has eased policies to stimulate the economy.