Stanley Druckenmiller on the Fed, Inflation, and the Election

The Fed's Dilemma: Avoiding Past Mistakes

Stanley Druckenmiller, chair and CEO of Duquesne Family Office, expresses concern that the Federal Reserve may be repeating mistakes made in 2021 by being trapped by forward guidance. He believes that the Fed did a commendable job in response to the COVID-19 pandemic in 2020. However, he argues that they continued aggressive actions, like forward guidance and maintaining a zero-interest rate policy, for too long after the economy began to recover.

Trapped by Forward Guidance in 2021

Druckenmiller points out that by the spring of 2021, it was clear the economy was booming. Despite this, the Fed continued buying securities and keeping rates at zero. In his opinion, this was because they were "trapped by forward guidance." It took 13 months from when inflation exceeded 2% to when the Fed finally raised rates, during which time they bought $2 trillion of bonds.

Current Asymmetry and Risk-Reward

Druckenmiller finds the current situation more nuanced than in 2021. Back then, high money supply growth and a booming economy made it clear the Fed was wrong on inflation. Currently, while inflation is still above target, the Fed argues that monetary policy is restrictive due to real inflation rates.

However, Druckenmiller relies on market signals rather than theoretical models. He observes that equities are at record highs, gold is at record highs, GDP is above trend, and credit markets appear healthy. He is surprised that the Fed is cutting rates by 50 basis points, despite not yet reaching the target, based on the theory that monetary policy is restrictive.

He doesn't have the same level of conviction as in 2021, but believes the risk-reward doesn't justify the Fed's current course. He hopes that if the data don't support their narrative, the Fed will adjust and avoid being trapped by forward guidance, as they were previously.

Inflationary Risks and the 1970s

Druckenmiller acknowledges the risk of an inflationary spike reminiscent of the 1970s. Inflation had fallen to 3% before the Fed started easing, leading to a resurgence and peaking at 12%. While he isn't predicting a repeat, easing into a melt-up in financial markets with current fiscal policy creates a significant risk. He expresses confusion over the rush to cut rates by 50 basis points, especially considering that the markets have priced in a 97% cut at the next meeting.

He agrees with Jim Grant's assessment that the Fed is "forward guidance dependent" rather than "data dependent." If inflation accelerates due to non-restrictive monetary policy and fiscal expansion, the Fed may have to tighten again, which could be disastrous for markets.

Fed Independence and the Election

Concerns about Fed Independence

Druckenmiller finds the idea of a "shadow Fed chair" horrible and irresponsible. He believes the Fed's biggest threat comes from making major mistakes. He criticizes the Fed's obsession with soft landings and fine-tuning, arguing that their real job is to avoid crises like the Great Financial Crisis, which he attributes to overly easy monetary policy that fueled a housing bubble.

The Druckenmiller Playbook for the Election

Druckenmiller admits uncertainty about the election outcome but emphasizes the importance of market indicators. He notes that market behavior suggests a growing conviction that Trump will win, evidenced by performance in bank stocks, crypto, and industries expected to benefit from deregulation.

He believes a "blue sweep" is unlikely, predicting a rough time for equities due to potential tax increases, reduced business confidence, and lack of deregulation. He sees a "red sweep" as more likely than a Trump presidency with a blue Congress. A red sweep might create animal spirits and deregulation, strengthening the economy initially, but could also trigger a negative response in the fixed income markets.

Druckenmiller clarifies that his firm is focused on the bond market rather than the stock market in response to potential election outcomes. He also believes a red sweep would lead to a more hawkish Fed.

Personal Views on the Candidates

Druckenmiller expresses dissatisfaction with both Kamala Harris and Donald Trump. He aligns with Bret Stephens' sentiment of deciding "who I'm going to vote against." He sees both candidates as supporting industrial policy, which he considers a departure from free market capitalism. He is more concerned about Harris' policies due to what he perceives as an anti-business and regulatory stance. However, he draws a "red line" at voting for Trump, citing a desire for a president with dignity and appropriate behavior.

Tariffs and Fiscal Policy

Druckenmiller states he is not in favor of tariffs, considering himself a free-market capitalist. While he acknowledges Trump's tendency to be a "blowhard," he hopes any tariff talk is a negotiating tactic. He also notes that the Biden administration has maintained Trump's tariffs.

On fiscal policy, Druckenmiller emphasizes the importance of addressing the US debt load. He believes tax cuts are less harmful than spending because they add to the capital stock, while government spending replaces it. However, he stresses that tax cuts should be paired with spending cuts. He criticizes Trump for taking entitlements off the table in 2016.

Market Views: Nvidia and Bonds

Nvidia

Druckenmiller admits selling Nvidia too early, calling it a mistake. He sold somewhere between $800 and $950, while the stock is now around $1300. He was initially aiming to hold it for years, but the rapid tripling of its price led him to believe the valuation was too rich. He remains a long-term believer in AI and continues to invest in its infrastructure. He would consider re-entering Nvidia at a lower price.

Bonds

Druckenmiller revealed that his firm shorted bonds the day the Fed cut rates by 50 basis points. He believes the ten-year yield should trade around the nominal GDP, which is 5.5%. If Powell is wrong and inflation accelerates, bonds could rise significantly. Conversely, if Powell is right, the downside risk is limited. Thus, he feels the risk reward favors shorting bonds.