Ray Dalio, Squawk Box, Bridgewater Associates Founder, President & CIO.
Bridgewater Associates founder Ray Dalio says a big fiscal stimulus program targeted at stressed businesses is needed, and the Federal Reserve has now done all it can do, short of a cooperative program with fiscal policy makers.
Dalio, in an opinion piece posted on LinkedIn, said he had been concerned the next downturn would lead to zero rates, but he was surprised it has been caused by the coronavirus. He also said Bridgwater’s stress tests of various companies and sectors shows that a number of companies and industries will have debt problems that will likely lead to restructurings.
The Fed on Sunday surprised markets by cutting interest rates a full percentage point, to the zero range, and announcing a new $700 billion quantitative easing program to buy Treasurys and mortgage securities.
Dalio admitted that it has been difficult trading the impacts of the coronavirus outbreak. He told the Financial Times that his firm did not know how to navigate the coronavirus and did not see an advantage in trading it. The newspaper reported that Dalio’s flagship fund, Pure Alpha Fund II, was down 20% for the year, as of Thursday. “So, we stayed in our positions and in retrospect we should have cut all risk,” the investor told the FT in a statement.
Dalio said the Fed has done all it can do as of now, and the next stage would be a coordinated policy with the government where the central bank buys assets used to fund deficits. Zero rates do not come without risks, and he has been worried the Fed would return to a zero target on the fed funds rate.
“Long-term interest rates hitting the hard 0% floor means that virtually all asset classes go down because the positive effects of interest rates falling won’t exist (at least not much). Hitting this 0% floor also means that virtually all the reserve country central banks’ interest rate stimulation tools (including cutting rates and yield curve guidance) won’t work,” Dalio wrote. “The printing of money and buying of debt assets that central banks are now allowed to buy almost certainly won’t work much (because bonds can’t be pushed much higher and they are also less likely to be sold to buy other assets of entities that are in financial trouble).”
Dalio said the decline in asset prices could have a big financial effect, when considering the assets that most investors and businesses hold assets that are financed with debt.
“Contrary to popular thinking, the markets will have a bigger effect on the economy than the economy will have on the markets,” said Dalio.
Pension funds and insurers are vulnerable and “have long-term liabilities that are funded with these equity and equity-like assets. I do the mark-to-market accounting of what this situation will be like for them by taking the present value of liabilities and looking at the expected returns of assets that they have to fund their liabilities. They will come up short,” he wrote. Dalio also said oil producers will have to sell assets and slash spending.
What is needed is a big fiscal stimulus with monetary cooperation, Dalio said, and it isn’t happening yet though Washington has taken some steps. “Our biggest risk comes from the possibility that our elected officials (who are the ones who control fiscal policy) will handle it badly,” he wrote. “That’s because it’s tough enough to know what to do during a big crisis and then do it boldly even when there aren’t divisive politics.”
Dalio said some fiscal policies have been put in place but so far they are not big enough, though there’s an indication Washington is moving towards “whatever it takes” mode.
Dalio said President Donald Trump’s proposal for a payroll tax holiday probably won’t be approved because of political opposition from both parties, but he may support other tax initiatives. Dalio said most important stimulus would be targeted to parts of the economy most impacted.
“Thus far, there has not been much debt support to industries that would go broke due to this shock though President Trump has called for Congress to authorize an additional $50 billion in subsidies for loan to SMEs through the SBA. This could free up a few hundred billions in loans; however, it ‘s not big enough and it’s not clear whether this measure will garner congressional Democrats’ support.”
Dalio said policymakers should guarantee the safety of the banks for the type of new lending that is needed.
Companies under stress may be expected to keep operating through bankruptcy, but he said that could be debilitating and monetary policy will be ineffective. “If handled badly, this could become a big political and social issue. If I were in President Trump’s shoes, I’d be generous and empathetic, especially as the news will become increasingly bad at this politically sensitive time,” he wrote. “I do expect politics to get in the way of doing the best things for the country as, above everything else, the number one goal of each of the sides is to get into power.”
Dalio said there are other hazards from zero interest rates. Real interest rates will likely move higher because of disinflation or deflation from lower oil and commodity prices, economic weakness and more credit problems.
“If that plays out in the typical way, rising credit spreads will raise debt service payments to weaker credits at the same time as credit lending shrinks, which will intensify the credit tightening, deflationary pressures, and negative growth forces. God help those countries that have these things and a rising currency, too.”