Amidst persistent anemic global growth and signs that central bank policy is losing its potency, investors should brace for a period of “lower than normal returns with greater than normal risk”.
That’s the view of Ray Dalio, founder and co-chief investment officer of the world’s largest hedge fund, Bridgewater Associates, who believes that the future of monetary policy will require a significant rethink amidst signs that current policies are losing their effectiveness.
In a investor note released overnight, Dalio, the 29th richest person in the world, suggests that having lowered interest rate to zero, or below, and pushing asset prices to elevated levels through the use of quantitative easing, the ability of monetary policy to further stimulate asset prices and the economy “is weaker than what is has ever been”.
In his view, current monetary easing is akin to “pushing on a string”, suggesting that the future of central bank policy, something that he has dubbed “Monetary Policy 3” will need more “money printing” rather than simply lowering interest rates to ever lower bounds.
“The future returns of assets will be low, which will be a problem given what the returns need to be to meet our future obligations,” says Dalio. “From the perspective of an investor, if you look at the level of the returns relative to levels of volatility, the expected reward-risk could make those who are long a lot of assets view that terrible-returning asset called cash as appealing.”
Dalio uses an example to explain the conundrum facing not only investors but central banks in this low return investment environment.
Take current bond yields (less than 2%) and cash (0%) and compare that to something like a 4% expected return on equities. Because of volatility, the 4% expected annual return pick up of equities over cash, or 2% over bonds, can be lost in a day or two. (For example, stocks fell by nearly 5% in a week earlier this month.) And then there is the feedback loop where a sell-off in the stock market in turn has a negative pass-through effect on the rate of economic activity. All that makes for asymmetric risks on the downside in the US—and the pictures in other countries are even more asymmetrical on the downside, as their interest rates are even lower and their risk premiums are nearly gone.
With the risk of volatility in financial markets spilling over into the real economy, and interest rate policy all but exhausted, Dalio suggests that investors should expect currency volatility to become “greater than normal”.
When interest rates can’t be lowered and relative interest rates can’t be changed, currency movements must be larger,” says Dalio. “To avoid economic volatility, currency movements must be larger. That reality creates currency wars, pegged exchange rate break-ups, and increased currency risk for investors.
“If the world’s largest economies all face the difficulty of pushing on a string, exchange rate shifts won’t create a needed global easing.”
While Dalio believes that central banks will continue to ease through further interest rate cuts and quantitative easing, he suggests that it will be less effective as there is now less “gas in the tank” than what was the case during earlier easing.
With current policy becoming increasingly ineffectual, Dalio suggests that monetary policy in the future will need to be targeted at spenders, not savers and investors.
“While negative interest rates will make cash a bit less attractive (but not much), it won’t drive investors/savers to buy the sort of assets that will finance spending. And while QE will push asset prices somewhat higher, investors/savers will still want to save, lenders will still be cautious lenders, and cautious borrowers will remain cautious,” says Dalio.
Dalio suggests that “Monetary Policy 3” will need to provide “money to spenders and incentives for them to spend it”.
With many governments running large fiscal deficits already, he believes that this mechanism could range from monetary and fiscal policy coordination – essentially the monetisation of government debt – to sending people cash directly, something that he dubs “helicopter money” after the famous statement made by former US Federal Reserve chair Ben Bernanke earlier in his career.
It all sounds like science fiction, and to many alarming. However, as we’ve seen from the likes of the Bank of Japan, and others, the limits of monetary policy nowadays only seem be governed by the level of ones imagination.
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