Some of the biggest names in investing see inflation as a real threat to markets

Published Sat, Jan 29 20228:38 AM EST

To combat the highest inflation in nearly four decades, the Federal Reserve signaled its readiness to hike interest rates as soon as March, but some of Wall Street's biggest investors — from David Einhorn to Seth Klarman — are convinced the threat from surging prices has grown too big to tackle with such light measures. Baupost Group's Seth Klarman said Thursday in a letter inflation poses a significant risk to the markets and he's hedging against outsized price gains. Also earlier this past week, Greenlight Capital's David Einhorn went so far as to say persistent inflation is eventually going to tip the U.S. economy into another recession, no matter what actions the Fed takes. "We don't know how bad the current bout of inflation will be, but we believe that mounting inflation and the related possibility of materially higher interest rates are posing a real danger to financial markets," Klarman in an investor letter obtained by CNBC. Einhorn's inflation warning sounded just as serious. "We believe that the inflation problem is so embedded that to successfully fight it the Fed would have to sacrifice the primacy of the financial markets," Einhorn said. "The higher prices of necessities will ultimately cause low-income consumers to cut back on other things. There are signs this is already happening." Both high-profile investors revealed that they started hedging against surging price pressures and rising interest rates. Einhorn has been investing in companies that would benefit from higher prices in industries from real estate to financials to commodities, such as Brighthouse Financial and Green Brick Partners . Inflation measures have shot up to historic highs left and right. The consumer price index surged 7% last month, the largest gain since June 1982. Meanwhile, a gauge the Fed prefers to measure inflation — the core personal consumption expenditures price index — rose 4.9% from a year ago, the biggest gain going back to September 1983. As inflation has failed to fade as anticipated, the Fed indicated Wednesday that it could soon raise interest rates for the first time in more than three years as part of a broader tightening of historically easy monetary policy. Listen to the bond market The stock market gyrated wildly this week as investors struggled to price the outlook for interest rates, but the bond market took Fed Chairman Jerome Powell's message seriously, according to the so-called bond king Jeffrey Gundlach. "There was a certain 'auto pilot' feel to the Fed's description today of the path ahead," Gundlach said in a tweet on Wednesday. "The bond market took it seriously. Always remember: Stocks need Bonds." The last time the Fed tightened policy from 2017 to 2019 didn't go well. The stock market tanked after Powell said the tightening process was on "autopilot" at a time when the U.S. economy was weakening. Following the Fed's update Wednesday, the yield on the 10-year Treasury note advanced as much as 10 basis points to 1.87%. The gap between two- and 10-year yields flattened to just above 60 basis points, the narrowest level in more than a year. A widening spread suggests a strengthening economy, while contracting spreads may herald weaker times. Legendary investor Stanley Druckenmiller said he will again be listening to the message of the bond market if the Fed backs away from its easy policies as promised. "The bond market and yield curve were certainly much better predictors of economic trends than me and 95% of economists," the CEO of the Duquesne Family Office told CNBC's Joe Kernen. "As long as the Fed follows through on this, I will once again be 'listening to the bond market' in the months ahead, as I did my first 35 years in the business," Druckenmiller said.

Traders work on the floor of the New York Stock Exchange (NYSE) on July 17, 2014 in New York City.

Spencer Platt | Getty Images News | Getty Images

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