Druckenmiller: The most radical policy combination in history (and what it means for Australia)

Legendary investor Stanley Druckenmiller has launched a broadside at Jerome Powell’s Federal Reserve economic strategy. Kicking off in an OpEd piece in the Wall Street Journal, and following up on Squawk Box on CNBC, Druckenmiller argued the Fed is out of step with current economic reality, playing into a Democrat Congress’s hands, and in danger of putting the US’s future into receivership.

In a piece penned with Christian Broda in the Wall Street Journal, he wrote:

“The emergency conditions are behind us. Inflation is already at historical averages. Serious economists soundly rejected price controls 40 years ago. Yet the Fed regularly distorts the most important price of all—long-term interest rates. This behavior is risky, for both the economy at large and the Fed itself.”

The combination of huge fiscal and monetary stimulus, which hit just as the economy was returning to pre-COVID trends, was one of “the most radical policy combinations in history.” 

Not only were “asset bubbles being courted” but the pressure of future fiscal burdens could well warp central bank policy for the near future.

“The Congressional Budget Office projects that in 20 years almost 30% of all yearly fiscal revenues will have to be used solely to pay back interests on government debt, up from a current level of 8%.

More taxes simply won’t be enough to bridge the gap, so pressures to monetize the deficit will inevitably rise over the years. The Fed should be adapting policy today to minimize these risks.”

When Druckenmiller, currently CEO of Duquesne Family Office, speaks, people tend to listen. 

The former chairman and CEO of Duquesne Capital closed that fund in 2010 as he felt unable to continue delivering 'high returns" to his clients. And by high returns, he was referring to 30% per year since 1981. When he shut the fund it was managing US$12billion in assets. (And while we're here Druckenmiller's investment philosophy is "top-down", that is, holding groups of long and short groups of stocks and using leverage to trade futures and currency. In 2020 he said he held both Bitcoin and gold, and held large positions in Microsoft, Salesforce and American Airlines. He is a philanthropist of note, in 2009 giving away more than $705million to a range of medical education and anti-poverty institutions. There. Now, back to the story.)

Druckenmiller and Broda pointed to the mass selling of Treasuries since April 2020 by “foreigners” as a ‘‘troubling” sign of international doubts “about the soundness of current and past policies”.

The Federal Reserve, they argue, is no longer doing its job as an unpopular, independent fiscal disciplinarian unmoved by political influence but instead playing into the hands of a spendthrift eager-to-please Democrat administration.

“Opportunistic politicians didn’t let the pandemic go to waste. Especially after the Trump years, Congress has decided to satisfy its long list of unmet desires.”

The pair further argued that amid “unambiguous” evidence of a strong recovery underway the Fed have more on their plate than the “narrow” recasting expectations over inflation. They believe the market has become decadent under the Fed’s watch and the evidence is everywhere: “Fed policy has enabled financial-market excesses. Today’s high stock-market valuations, the crypto craze, and the frenzy over special-purpose acquisition companies, or SPACs, are just a few examples of the response to the Fed’s aggressive policies.

“Chairman Jerome Powell needs to recognize the likelihood of future political pressures on the Fed and stop enabling fiscal and market excesses. The long-term risks from asset bubbles and fiscal dominance dwarf the short-term risk of putting the brakes on a booming economy in 2022.”

Druckenmiller, CEO of Duquesne Family Office, then took his opinions on the road, appearing on CNBC's Squawk Box, where he referred to the Fed Reserve's policy as "certainly the most radical policy by a long shot that I've ever seen relative to the economic circumstance" adding "I can't find any period in history where monetary and fiscal policy were this out of step with the economic circumstances. Not one."

He continued:

"In six weeks last spring we did more QE purchase of Treasuries than we did 2009-2019. I don't have a problem with that. We were in a black hole, no one knew where we were headed. 

What I have a problem with is the Fed is expected to do $2.5TN of QE after vaccine confirmation and after retail sales are above trend. So the Black hole didn't occur and that's wonderful, we're all happy. But we're still acting as if we're in a black hole and the economy is actually accelerating."

This excessive stimulus is causing an evacuation of US Treasuries by foreign investors. These inflows are critical for offsetting America’s current account deficit. Continued outflows – which Druckenmiller expects – could send the US Dollar into a long bear market, as US$500 billion of annual inflows to treasuries reverse.

Why didn't the dollar go down last year then? Funds were flowing heavily into US equities, particularly ‘at-home winners’ like Google, Zoom, and Microsoft, he told CNBC. With equity flows now shifting away from growth stocks (which the US dominates) and COVID-winners, and towards cyclical and value stocks, that trend has died off now, and the US dollar has begun to decline.

What does all this mean for Australian investors?

Australian investors have increased their exposure to international equities in recent years, particularly US equities. For unhedged international equities, a declining US Dollar could act as a significant long-term drag on performance.

ASX-listed companies with significant exposure to US Dollar denominated earnings could also be at risk, and there are a lot of those on the ASX. Some even report their earnings in US Dollars. Here is a selection of ASX large caps with significant US Dollar exposure, or which report in US Dollars:

• Afterpay
• Amcor
• Aristocrat Leisure
• BHP
• Computershare
• CSL
• Fortescue Metals Group
• James Hardie Industries
• Macquarie Group
• Newcrest Mining
• QBE Insurance
• ResMed
• Rio Tinto
• Woodside Petroleum

Some of these companies may be able to offset the currency losses either through volume growth, or higher prices. Others may struggle to do so. But regardless, it’s an important consideration when assessing the future earnings prospects of companies with US exposure.