Bridgewater is betting on a sell-off in corporate bonds this year as the world’s biggest hedge fund takes a gloomy view on the trajectory of the global economy.
The wager against US and European corporate debt underscores Bridgewater’s assessment that recent weakness across major financial markets will not be shortlived.
“We’re in a radically different world,” Greg Jensen, one of Bridgewater’s chief investment officers, told the Financial Times. “We’re approaching a slowdown.”
Jensen, who helps lead investment decisions alongside co-CIO Bob Prince, warned that would be far stickier than economists and the market currently predict, which could pressure the US Federal Reserve — the world’s most influential central bank — to raise interest rates higher than expected by many on Wall Street.
He added that if Fed policymakers were committed to bringing inflation down to its target of 2 per cent, “they may tighten in a very strong way, which would then crack the economy and probably crack the weaker [companies] in the economy”.
He added: “We think nominal growth will hold up. The real economy will be weak, but not a self-reinforcing weakness.”
Bridgewater had already been positioning for a sustained sell-off in the $23tn US government bond market, and has similarly wagered on Wall Street equity prices falling — even after they have already collectively lost $9tn in value this year. High-grade US corporate bonds are down about 12 per cent this year on a total return basis, while those in Europe have fallen 10 per cent in local currency terms, according to ICE Data Services indices.
Higher interest rates have led to a jump in mortgage rates for consumers and higher borrowing costs for companies securing new debt. Should companies fail to clinch fresh financing they could fall into financial distress or face bankruptcy, and Jensen said the bearish position on corporate bonds reflected Bridgewater’s belief that “it’s going to start to get much more expensive to borrow money”.
Top Fed officials have signaled their intent to slow the economic expansion as they attempt to rein in the highest inflation registered since the 1980s. To do that, policymakers have started to aggressively raise interest rates from historic lows and this month they will begin to reduce the size of the Fed’s nearly $9tn balance sheet.
Jensen said the Fed’s decision, coupled with tighter policy from a panoply of central banks across the globe, would drain liquidity from the financial system. In doing so, he said the prices of many assets that rallied last year would come under pressure.
“You want to be on the other side of that liquidity hole, out of assets that require the liquidity and in assets that don’t,” he said.
Bridgewater in April used baskets of credit derivatives in Europe and the US to make the bet against corporate bond markets, according to people familiar with the trade. The spread on the main high-yield CDX index, which tracks insurance like products that protect against defaults on riskier corporate bonds, has surged from around 375 basis points at the beginning of April to 475 basis points this month, indicating an increased cost to protect against issuers reneging on their debts.
Jensen declined to say how Bridgewater had structured the short bet on credit or how large the position was.
Even with the Fed’s current hawkish rhetoric, Jensen said he ultimately believed that the Fed would blink and accept inflation above its 2 per cent target. Policymakers, in his view, will be unable to tolerate a stock market sell-off and the high unemployment that would probably result from raising rates high enough to bring inflation down to that threshold.
Otherwise he estimated stocks could “crash” a further 25 per cent from current levels if the Fed was unrelenting in its push to tackle inflation.
The year’s earlier investments have paid off handsomely for Bridgewater, which is best known for its global macro approach in which it attempts to profit by making bets based on economic trends. The fund managed $151bn in assets at the start of the year and its flagship Pure Alpha investment fund is up 26.2 per cent this year through the end of May, according to a person familiar with the matter, compared with a 13.3 per cent decline for the benchmark S&P 500 over that period.
Jensen blamed current volatility in the US stock market in part on the Fed’s conclusion of quantitative easing. Without the central bank in place to absorb the large supply of Treasury bonds, other investors have had to step in, and in doing so, sold off other holdings such as stocks. “So you’re seeing this see-saw between bonds selling off or equities selling off,” he said.
As for areas where the fund is bullish, Jensen said he favored commodities and inflation-indexed bonds. Both asset classes would, he said, benefit in a stagflationary environment — a toxic combination of low growth and rising prices.
On the biggest systemic risk to markets and the economy
Greg Jensen, Bridgewater’s co-chief investment officer, warned that the biggest systemic risk facing the US economy was that the Federal Reserve was effectively out of ammo.
Sky-high inflation has limited the tools at both the Fed’s and federal government’s disposal, given an intervention by either would probably stoke price pressures already weighing on the country, he said. He cautioned that policymakers in Washington would have to “essentially allow a recession because the trade-off with inflation is so bad”.
The Fed has in recent years supported financial markets during times of distress by both cutting interest rates to historic lows and by spending trillions of dollars on Treasuries and mortgage bonds, purchases that have helped inflate the value of other, riskier assets. But Jensen said policymakers would struggle to use either while inflation is so high.
“You have hit the limits of interest rates and private sector debt and you have hit the limits of, let’s say, printing money and using fiscal policy,” he said. “The biggest systemic risk is that markets are not used to the type of drawdowns that you have when the central bank can’t use monetary policy into weakness.”