The U.S. Federal Reserve risks weak economic growth throughout this year due to its backward-looking, “draconian” rate hikes, warned Wall Street’s best-known tech sector bull.
ARK Invest founder Cathie Wood, who became famous for her prescient bets on disruptive technologies led by companies such as Tesla, argued the Fed must temper its policy given that leading economic indicators are flashing red.
These include speculative bets indicating an expectation for rising bankruptcies via securities called credit default swaps (CDS) and a flattening of the yield curve: the premium investors demand for holding benchmark 10-year bonds over short-dated two-year bonds.
“It is ignoring deflationary and dangerous signals,” she posted to Twitter on Sunday, arguing that the consumer price index lagged real-time developments. Some economists say setting policy using this type of data is equivalent to driving by looking through the rearview mirror.
“Consumer sentiment is lower today than levels reached during the Global Financial Crisis in 2008–09 and the two recessions in 1980–82, when Fed Chairman [Paul]Volcker was choking 15%-plus inflation with 20% interest rates,” she added.
Volcker is best known for taming double-digit inflation with his hawkish policies during the early 1980s. This came at the cost of losing his job to Alan Greenspan, now famous for backstopping Wall Street’s risky bets through the so-called “Greenspan Put.”
Wood and many of her peers benefited from the legacy of the latter’s accommodative rate policies that inflated asset prices, especially for high-growth stocks favored by ARK Invest.
Subsequent Fed chairs, including Ben Bernanke and Janet Yellen, have all preferred to maintain low rates as inflation remained relatively tepid. Current chair Jay Powell even said in March 2021 that he anticipated rates would not rise “at least until 2024.”
That prediction had a very short shelf life. Instead he began in March of this year with a 25-basis-point hike and has since raised rates to 1.75% as of last week in an aim to cut off inflation.
For Wood, this pace was more severe, even if the absolute number remains small and real rates after accounting for inflation remain deeply negative and thus stimulative for the economy.
“Volcker doubled the Fed funds from 10% to 20% in less than a year. Powell’s Fed has increased the funds rate 7-fold in the last year and is pointing to another double from here,” she wrote. “Its moves already are more draconian than Volcker’s.”
Plunging value of ARK Innovation
Wood said CDS prices were hitting levels not seen since COVID first escaped its confines of China, while a flattening of the yield curve, and even more so an inversion of the curve, typically presages recessions in the market.
This is because the Fed can typically anchor expectations on the short end of the curve through its control of the Fed funds rate. By comparison, longer duration maturities in the bond market reflect the broader market’s inflation expectations. If 10-year yields fall, it suggests investors are pricing in an economic slowdown.
“In our view, the U.S. fell into recession during the first quarter. If massive inventors bloat real GDP in the second quarter, they will unwind and hurt growth for the rest of the year.”
A recession is defined as two consecutive quarters of shrinking economic output. Officially it is declared by the National Bureau of Economic Research (NBER).
Inventories are considered cyclical white noise that can contribute or detract from growth in any given quarter but typically net themselves out on an annual basis. Any second-quarter GDP data driven by rising inventories would be considered weak on a qualitative basis.
Wood may be urging the Fed to reduce its pace out of her own interest, since many of the stocks in her funds have fallen from their highs in November 2021 after the Fed signaled it was no longer convinced inflation was transitory.
ARK Innovation, her flagship exchange-traded fund, has seen a drop of over 23% last year and has plunged 60% so far in 2022.
“The Fed seems to be worried more about its legacy than the economy,” she wrote.
Sign up for the Fortune Features email list so you don’t miss our biggest features, exclusive interviews, and investigations.