Billionaire investor Stanley Druckenmiller might be the best to ever do it, at least from a pure returns perspective. His firm, Duquesne Capital Management, which closed in 2010, generated average annual returns of 30% for three decades. That's better than Warren Buffett and Berkshire Hathaway.
Although Duquesne Capital is no more, Druckenmiller still invests through the Duquesne Family Office, and is not afraid to go against the grain. The George Soros protege is now making a bet that goes against the broader view of the market and the Federal Reserve, according to reported remarks of people who heard him speak at a conference in early October. Does he know something Wall Street doesn't?
Betting on a bond bust
The majority of the market and the Federal Reserve believe inflation will continue to slow and the Fed will keep lowering interest rates through 2025. The CME Group's FedWatch tool, which tracks the likelihood of interest rate changes by looking at one-month futures prices, indicates that the majority of traders (as of Oct. 15) expect the Fed to lower interest rates by an additional 50 basis points this year and get its benchmark rate down to a target range of 3.25% to 3.50% by the end of 2025. Keep in mind that these future projections of interest rates are constantly changing.
The Fed's "dot plot" also currently charts a similar path. The dot plot shows how each member of the Federal Open Market Committee (FOMC) thinks interest rates will trend and then compiles a consensus. The dot plot is updated every three months. The Fed believes that with inflation trending lower, it now needs to worry about the labor market, which has seen unemployment trending higher until the last two months. The Fed is trying to engineer a "soft landing" for the economy where inflation falls and gets back to the Fed's preferred 2% target without previous interest rate hikes tipping the economy into recession.
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Druckenmiller is taking the other side of this bet, reportedly recently unveiling at a conference that he is shorting U.S. Treasury bonds. Bets against U.S. government bonds now account for 15% to 20% of Druckenmiller's portfolio, according to reports of what people at the conference said.
A bet against Treasury bills or bonds is effectively a bet against the current view that interest rates will fall. Bonds have an inverse relationship to bond yields, so if bonds fall, yields rise. The federal funds rate influences bond yields, although most yields do not move solely based on the federal funds rate. Druckenmiller also reportedly said inflation could surge to levels seen in the 1970s. If inflation surges, the Fed will not be able to drop interest rates as much as the market thinks or even at all because the economy will be too hot to stimulate with further cuts.
We don't know the exact bet
We don't know the exact bet Druckenmiller is making. For instance, we don't know the duration of bonds that Druckenmiller is shorting. Being short of the two-year Treasury bill is different from being short of the 30-year. Druckenmiller also reportedly said he is unsure how long the trade will take to unfold. It could take six months or six years, he said. Additionally, Druckenmiller is worried about "bipartisan fiscal recklessness."
For all we know, Druckenmiller's bet could have more to do with government spending and the national debt than anything else. If debt levels get too high and the market starts to worry about the government's ability to pay its debt or interest payments, investors would demand higher interest rates for the added risk, which would tank bond prices.
Still, given his comments on inflation, Druckenmiller does seem to be playing contrarian to the Fed and the general market. While retail investors should listen to Druckenmiller and try to get into his mindset, it's not a good idea to completely shift your strategy when the exact trade is not known. The motive of institutional investors is not always entirely clear. But thinking about and being open to opposing views -- and then doing your own due diligence -- is what makes a good investor.
