David Einhorn is worried about rising inflation, and he heavily points his finger at one person for making it worse than it had to be: Federal Reserve chairman Jerome Powell.
In Greenlight Capital’s third-quarter letter obtained by Institutional Investor, the struggling hedge fund manager cynically noted the Fed and Powell specifically went from characterizing inflation as “transitory” to “frustrating.”
“But why should he feel frustrated?” asks the letter, which is officially signed by Greenlight and not Einhorn. “It’s not like he has done his best to fight inflation without success; he hasn’t lifted a finger to fight inflation. Instead, he has maintained a policy designed to create inflation. As a result, inflation is here and it appears poised to worsen.”
Einhorn has been worrying about rising inflation for more than a year.
Greenlight initially told clients in its first-quarter 2020 letter that it expected global inflation to rise, one of the first hedge fund managers to go on record predicting this development.
“We expect policymakers to target and applaud mid-single-digit inflation, which combined with interest rate suppression, will be the only way to outgrow the mounting debts,” Greenlight said at the time, reminding clients that it had held a position in gold for a number of years. “It might get tricky a few years from now if inflation accelerates further. The Fed has demonstrated [that] it doesn’t have the stomach to slow the economy by reining in policy.”
In its second-quarter 2020 letter, Greenlight told clients that it had determined that the most direct method of profiting from higher inflation was to bet on an unexpected increase in the U.S. Consumer Price Index (CPI). It was thus investing in inflation swaps, which it described as a highly liquid derivative of Treasury Inflation-Protected Securities (TIPS). Their value is based on the official CPI at a future date, Greenlight explained.
Despite this prescient prediction and determined strategy, Greenlight has had trouble converting them into strong performance.
Last year Greenlight was up just 5.2 percent compared with 18.4 percent for the S&P 500, while in the first nine months of this year Greenlight was down 5.6 percent.
In the third-quarter 2021 letter, Greenlight stressed that it doesn’t blame the Fed for not taking much action, mindful of the potential negative ramifications.
“If the Fed were to actually fight inflation, it would harm the financial markets and trigger a fresh recession that our fiscal and monetary policies aren’t capable of addressing,” the letter asserted. “We don’t think our leaders are prepared to take responsibility for doing so.”
As a result, Greenlight called the Fed’s strategy “obfuscating inflation, claiming it’s transitory and just hoping that it goes away on its own. Or, at worst, it can be dealt with over time by gradually reducing bond purchases and ultimately gradually increasing interest rates.”
Greenlight, however, thinks this strategy is increasingly unlikely to work out well.
Whereas some price spikes due to supply chain bottlenecks are likely to eventually reverse, others will probably persist, it added.
One reason: the impact of ESG (environmental, social, and governance) investing.
The letter explained that ESG investing has led to an aversion to investing in fossil fuels. Now, however, energy prices are surging, contributing to inflation. But this surge in pricing no doubt won’t result in an expansion of the coal supply, for example, which could mitigate the price rise.
“The structural problem around the current global energy crisis—which is why it isn’t going away anytime soon—is that politicians have decarbonized supply faster than they can decarbonize demand,” Greenlight elaborated. “In order for prices to fall, demand needs to be destroyed, which leads to a growth problem well before anyone gets a chance to raise rates.”
Meanwhile, housing and rents—two of the most important drivers of inflation—are likely to continue to drive up the CPI, Greenlight added, stressing that “we unquestionably have a labor shortage” for a variety of reasons. They include what it deems to be voluntary retirement among many people who have made a lot of money from the stock market.
“It’s a recipe for demand-pull and cost-push inflation at the same time,” the hedge fund asserted. Which places the Fed in what it called a tough predicament.
Greenlight warned: “The risk is that the capital markets lose confidence in the Fed policy and develop a view that the Fed is ‘behind the curve’ in dealing with sustained inflation.”
