Speculation abounds as to what the Federal Reserve’s interest-rate hikes will mean for the economy and financial markets.
The prognosis isn’t good, says Ray Dalio, founder and co-chief investment officer of Bridgewater Associates, the world’s biggest hedge-fund manager
Looking at inflation, “my guesstimate is that it will be around 4.5% to 5% long term, barring shocks (e.g., worsening economic wars in Europe and Asia, or more droughts and floods),” Dalio wrote in a commentary on LinkedIn.
“In the near term, I expect inflation will fall slightly, as past shocks resolve for some items (e.g., energy).”
Dalio foresees real, or inflation-adjusted, interest rates of zero to 1% in coming years. “That would be relatively high but tolerable for debtors and relatively low but tolerable for creditors,” he said.
Bond Yield Forecast
Adding the inflation and real rates numbers together generates projected nominal bond yields — the numbers that show up on your computer screen. Dalio expects a relatively flat yield curve, “until there is an unacceptable negative effect on the economy.”
So he forecasts a range of 4.5% to 6% for long- and short-term nominal bond yields.
Given the federal government’s hefty debt load, he thinks yields must rise to the higher end of that range to entice investors to buy Treasury securities. Government debt totaled $28 trillion as of Sept. 30.
The yield increase implies “a significant fall in private credit that will curtail spending,” Dalio said. “This will bring private-sector credit growth down, which will bring private-sector spending and, hence, the economy down with it.”
Scroll to Continue
The rate rise will produce about a 20% drop in stock prices, Dalio predicted. That too will depress the economy, he said.
“When people lose money, they become cautious, and lenders are more cautious in lending to them, so they spend less,” Dalio said.
“My guesstimate [is] that a significant economic contraction will be required, but it will take a while to happen because cash levels and wealth levels are now relatively high.”
Cathie Wood’s View
Famed investor Cathie Wood, chief executive of Ark Investment Management, views inflation and the economy somewhat differently.
Federal Reserve Chairman Jerome Powell has misread the environment in comparing this period to the late 1970s and early ‘80s, Wood said in a webinar. That’s when then-Fed Chairman Paul Volcker pushed interest rates way higher to quell inflation.
He faced an economy that took 15 years to “work up an inflation frenzy,” she said. “This is more like a 15-month problem.”
So, “to use the same resolve this time will prove to be a mistake,” Wood said. “We think we’re already in a recession.”
She considers consumer-price gauges a lagging indicator. Gold is the best leading indicator for inflation, she said. And it has traded at a range of about $1,700 to $2,075 over the past two years, peaking in August 2020, Wood noted.