Rebecca Patterson has a message for Federal Reserve Chairman Jerome Powell: It’s time to get even more hawkish.
The chief investment strategist at Bridgewater Associates, the world’s largest hedge fund, says interest rates will need to rise a lot higher than Powell thinks in order to tame inflation. The aggressive policy tightening that’s expected will continue to lift yields of all maturities, which helps explain why the firm is shorting Treasuries across the curve.
“Markets are discounting that you are going to have inflation not back down to 2%, but to around 3%, over the next three years -- and that’s with a lot of Fed tightening,” Patterson said during an interview at Bridgewater’s campus in Westport, Connecticut. “The question to us is if it’s enough to get inflation to where markets are discounting it. We think the risk is that it is not.”
Patterson is the type of market veteran who central bankers listen to, based on her reputation for making correct calls in a career that’s taken her from cub reporter at a local newspaper in Florida to the right-hand side of Ray Dalio, Bridgewater’s famous founder. The 53-year-old has been a member of the Fed’s advisory committee, and has appeared on American Banker’s annual Most Powerful Women in Banking list multiple times.
These days, Patterson and her Bridgewater colleagues are looking suspiciously at market pricing that suggests a peak federal funds rate of just over 3% in this tightening cycle, above the 2.8% level that policy makers have signaled will be needed to control inflation. That outlook alone has already helped lift benchmark 10-year Treasury yields to a more-than three-year high of almost 2.98% this month. Yet the U.S. breakeven rate -- a bond-market gauge of expectations -- still projects headline inflation averaging about 2.9% over the coming decade.
The consumer price index rose by an annual rate of 8.5% in March, with the core rate -- which strips out food and energy costs -- at 6.5%. Bridgewater expects core CPI to remain at 6.5% in a year’s time. While she declined to say exactly how much she believes the Fed needs to hike, Patterson said the central bank’s benchmark rate needs to go much higher than expected to get inflation back down to anywhere near the Fed’s 2% target for the personal consumption expenditure index, which runs about 40 basis points below CPI, or even to what breakevens are pricing.
To Patterson, that all adds up to a further rise in yields.
“Ten-year Treasury yields have decent room to run,” Patterson said during the April 12 interview. “3% is really easy to see, and I wouldn’t rule out that we could see 4%.”
Patterson’s not alone in her thinking about the Fed funds rate. Deutsche Bank AG economists warned on Tuesday that the central bank likely needs to engage in the most aggressive monetary tightening since the 1980s, assuming “conservatively” that the benchmark rate needs to be lifted well into the 5% to 6% range.
To bulletproof their funds for an environment of persistent inflation and higher rates, Bridgewater also is invested in diversified and cyclical commodities, gold and inflation-linked bonds. In equities, the firm is short U.S. stocks and long Japan given the sharp withdrawal of liquidity by the Fed.