The Federal Reserve is expected this week to deliver a third consecutive 0.75 percentage point interest rate hike following a higher-than-expected consumer price index reading in August and hawkish comments on rate hikes from Fed leaders that have put pressure on stock prices.
Legendary hedge fund manager Ray Dalio has a pessimistic prediction for stocks and the economy if interest rates go up to 4.5 percent.
The current federal funds rate target range is 2.25 percent to 2.5 percent. Increasing rates to about 4.5 percent would lead to equity prices falling around 20 percent on the present value discount effect, Dalio wrote. In addition, Dalio estimates a 10-percent negative impact from declining incomes.
The rate market suggests traders have fully priced in a 75-basis-point hike this week by the Federal Reserve, with a slight chance for a full percentage point move, Bloomberg reported. Traders expect the Fed fund rate to peak at close to 4.5 percent in 2023.
“It looks like interest rates will have to rise a lot (toward the higher end of the 4.5% to 6% range),” the billionaire founder of Bridgewater Associates LP wrote in a Sept. 13 LinkedIn article. “This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.”
Federal Reserve Chairman Jerome Powell acknowledged that interest rate hikes cause economic pain. “But that’s the point: To get rid of inflation, the Fed needs to reduce demand. And that may mean falling stock prices, hiring and spending,” CNN reported.
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Dalio predicts it will take a while for significant economic contraction to happen because cash levels and wealth levels are relatively high, “so they can be used to support spending until they are drawn down,” he wrote. “For example, while we are seeing a significant weakening in the interest rate and debt dependent sectors like housing, we are still seeing relatively strong consumption spending and employment.”
Dalio founded Bridgewater in 1975 and grew it into the world’s largest hedge fund with 107 clients and $154 billion in assets under management. The 81st richest person in the world, Dalio has an estimated real time Forbes net worth of $19.1 billion.
Some other Dalio predictions and observations include: