No one doubts that the Federal Reserve (Fed) will raise interest rates next Wednesdaythe only question is how sharp the rise will be: 75 or 100 basis points. The US central bank’s plan is push interest rates into restrictive territoryaround 4%, and keep them for a while to tame inflation, a decision that experts believe could cause a recession. “Interest rates at 4.5% will produce a negative impact of approximately 10% on share prices”says the famous Richard ‘Ray’ Daliofounder of Bridgewater Associates.
“With inflation well above what people and central banks want (U.S. core rate is 7.4%) and a low unemployment rate (3.7%), it is obvious that central banks should tighten monetary policy”, points out the legendary investor, who highlights thathe expected inflation for the next few years differs greatly from expectations From the market. “Right now, markets are pricing in 2.6% inflation in the US over the next 10 years. My estimate is that it will be around 4.5% or 5% in the long term, barring shocks (worsening economic wars in Europe and Asia, more droughts and floods, etc.)”, he details.
“Given my assumptions about inflation and real returns, I conclude that the long and short rates will be between 4.5% and 6%”, adds Dalio, “In the short term, I expect inflation to decline slightly as past shocks are resolved for some items (eg energy) and then rise again towards 4.5% or 5% in the medium term”.
At the same time, Dalio points out that «at the same time there is the effect of supply and demand on interest rates, which results from the number of loans and the number of credits there are». The investor believes that the US government and the Fed «are going to have to sell a lot of debt to finance the deficit, around 8 or 9% of GDP». “The question is where will the demand for this huge supply come from or how much will interest rates have to rise to reduce demand for credit from the private sector to balance supply and demand,” he explains.
At this point, the famous investor points out that “interest rates will have to rise towards the upper end of the range from 4.5% to 6%” for it to occur “a significant drop in private credit that will reduce spending”. «This will reduce the growth of private sector credit and private sector spending and, therefore, the economy,» he points out, while estimating the fall of the stock markets by more than 20% if such a movement occurs, as well as a “negative impact of approximately 10% due to the decrease in income”.
Likewise, Dalio has also estimated what the fall in the markets will mean for the economy, underlining that «when people lose money, they become cautious, and lenders are more cautious when lending to them, so they spend less». “My guess is that A significant economic contraction will be necessary, but it will take time because cash and wealth levels are now relatively highso they can be used to support spending until they are reduced,» he says.
According to the founder of Bridgewater Associates, we are now seeing a similar situation as, “although we are seeing significant weakening in interest rate and debt dependent sectors such as housing, we continue to see consumer spending and employment relatively strong.
Finally, Dalio points out that the result “likely” is that the rate of inflation “will remain significantly above what the people and the Fed want it to be (while the year-on-year inflation rate will decline)”. In turn, «interest rates will go up, other markets will go down, and the economy will be weaker than expected…and that’s without taking into account worsening trends in internal and external conflicts and their effects.»