An interesting week in markets as stocks continued to climb higher as bond yields continued to retrace slowly higher. Although the market continues to price rate cuts, a chorus of finance gurus have commented that it is unlikely inflation will return to the 2% inflation target. Still, many see rate cuts likely as a result of the rising real rate. (See out in-depth discussion here.)
Finance Gurus did not see inflation returning to the feds 2% target
Mohamed El-Erian: Speaking on Bloomberg and writing in the FT warned that disinflation is unlikely to continue and would probably get stuck “around 3%.” He sees cost pressures building as a result of events in the Red Sea and continued labor market strength and wage pressures.
Ray Dalio: On CNBC in Davos said he expects the inflation rate to settle around 3-3.5%, and that noted that “a 4% bond yield is probably not attractive enough.”
Larry Summers: On Wall Street Week, while not addressing inflation directly, noted that budget deficits are “more serious” than in the early 90’s, and that he reasonably thinks the US is headed towards a deficit of 10% of GDP.
Finance Gurus see geopolitical risks that are not priced into markets
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Ray Dalio noted that markets appear to be “fairly priced” given current conditions, but warned risks including US elections, geopolitical events, and climate change are not priced in.
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El-Erian noted risks to shipping in the Red Sea and continued wage pressures.
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Summers also noted a worsening economic situation in China, commenting that over investment “is a precursor to bad debt.”
So many top gurus are cautious on risks to markets, but at the same time see inflation remaining high. As Stan Druckenmiller as commented, this may be the hardest time to read the markets in history. If the fed allows inflation to remain above target for some time, we may indeed be in a poor environment to hold cash or bonds. However, if any of the many market risks materialize, stocks may be a risk. Dalio therefore recommends a ‘neutral portfolio.’
