(Kitco News) With the Federal Reserve continuing to pursue aggressive tightening, Ray Dalio, the billionaire founder of Bridgewater Associates, calculated that interest rates will have to rise to at least 4.5%, forcing stocks down by 20%.
"I estimate that a rise in rates from where they are to about 4.5 percent will produce about a 20 percent negative impact on equity prices (on average, though greater for longer duration assets and less for shorter duration ones) based on the present value discount effect and about a 10 percent negative impact from declining incomes," Dalio said in his latest LinkedIn post.
In order to get to the 4.5% interest rate estimate, Dalio looked at inflation and real yields. "The process starts with inflation. Then it goes to interest rates, then to other markets, and then to the economy," he explained.
And his outlook on markets and the U.S. economy is pretty gloomy. "Right now, the markets are discounting inflation over the next 10 years of 2.6 percent in the U.S. My guesstimate is that it will be around 4.5 percent to 5 percent long term, barring shocks (e.g., worsening economic wars in Europe and Asia, or more droughts and floods) and significantly higher with shocks," Dalio said when describing his inflation estimates.
Considering this and real yields, Dalio sees long and short rates between4.5% and 6%. "The higher end of this range would be intolerably bad for debtors, markets, and the economy, I'm guesstimating that the Fed will be easier than that (though 4.5 percent is probably too easy)," he said.
The Fed's fund rate is currently in a range of 2.25%-2.5%. And this week, markets are pricing in a third consecutive 75-basis-point increase on Wednesday.
Dalio is forecasting that the Fed will go all the way to 4.5%, which will have severe consequences for the stock market and the economy.
"The rise in interest rates will have two types of negative effects on asset prices: 1) the present value discount rate and 2) the decline in incomes produced by assets because of the weaker economy," Dalio wrote. "When people lose money, they become cautious, and lenders are more cautious in lending to them, so they spend less. My guesstimate 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, so they can be used to support spending until they are drawn down."
