I like listening to Bob Prince of Bridgewater when shows his face a few times a year. He released a note about a month ago that I just caught up on. The title of the note is “The Tightening Cycle Is Approaching Stage 3: Guideposts We’re Watching” – and the takeaway on his crystal ball is below:
Going forward: in prior research, we’ve laid out what we think is a reasonable path to equilibrium. In a nutshell, we see it looking something like this.
- To get 2% inflation, you need a deceleration in wage growth from the prior 5% to about 2.5%.
- To reduce wage inflation, you need to cut nominal spending and income growth in half to 3-5% and raise the unemployment rate by 2% or more.
- To raise the unemployment rate, you need to drive nominal GDP growth materially below wage growth and compress profit margins enough to produce about a 20% decline in earnings.
- After that, you need to hold short-term interest rates steady for about 18 months, until 2.5% wage growth, 2% inflation, and 2% real growth are sustainably achieved.
- Then cut short-term interest rates to about 1% below then-existing bond yields.
So are we on track or not? Below, we scan through some of the guideposts we are looking at to assess where we are in the tightening cycle.
Bridgewater
As for what to do about it, one can debate macro implications on portfolio construction until blue in the face. Or one can just follow the below IQ meme (h/t @marhelmdata), which is what I prefer.
