As the world waited for the Federal Reserve to announce its third “jumbo” interest rate hike, Ray Dalio, the founder of Bridgewater Associates, gave a warning to anyone who was still holding out hope that prices for beaten-down assets would soon go back up.
Dalio thinks that the Fed must keep raising interest rates by a lot if it wants to get inflation under control.
This and other things, like the ongoing war in Ukraine, Dalio thinks that stocks and bonds will continue to lose value as the U.S. economy slides into a recession in 2023 or 2024.
“Right now, we’re very close to a year with no interest. I think it will get worse in 2023 and 2024, which could affect elections,” Dalio told MarketWatch editor-in-chief Mark
DeCambre in an interview at the first MarketWatch “Best New Ideas in Money” festival, which started in Manhattan on Wednesday morning.
Fed Chairman Jerome Powell has promised that the central bank will do everything it can to stop inflation, even if that means crashing markets and the economy.
Ray Dalio thinks the Fed needs to raise benchmark interest rates to between 4% and 5% to make this happen.
Now that the Fed has raised interest rates a total of three times by 75 basis points, the Fed funds rate will go back above 3% for the first time since before the financial crisis.
“They need to get both short-term and long-term interest rates up to around 4.5 percent, or even higher,” he said. Because “economic pain” is the only way the Fed can fight inflation successfully.
According to the CME’s FedWatch tool, futures traders think that the Fed could raise the benchmark rate, which supports trillions of dollars in assets, to as high as 4.5% by July.
But traders only see a small chance that the rate will reach 5% before the Fed decides to start cutting rates again.
After reaching its highest level in more than 40 years this summer, inflation in the U.S. has gone down a bit.
A report on consumer price pressures in August sent financial markets into a tailspin last week. Parts of “core” inflation, like housing costs, seemed more stable last month than economists had expected.
The ongoing energy crisis in Europe has caused prices for everything from heat to consumer goods to go up even more.
Ray Dalio showed, using some of the most basic rules of corporate finance, why higher interest rates are bad for both financial assets and real assets like the housing market.
Simply put, when interest rates go up, investors must raise the discount rate they use to figure out the present value of future cash flows, or interest payments, tied to a stock or bond.
Since higher interest rates and inflation are basically a tax on these future income streams, investors usually make up for it by giving the asset a lower value.
“When you make an investment, you pay a lump sum for future cash flows. To figure out how much they were worth, we use the present value and a discount rate. And that’s why all boats rise and fall at the same time,” Ray Dalio said.
“Bringing interest rates down to zero or close to zero raises the prices of all assets,” Dalio said. “And when you do it the other way around, the effect is the opposite.”
Ray Dalio said that he thinks stocks will lose more money, but he said that the bond market is a bigger worry.
Dalio thinks that the problem is that the Fed is no longer buying the government’s debt with money. The Fed plans to double the rate at which Treasury and mortgage bonds will be taken off its balance sheet in September.
“Who will buy those bonds?” Dalio asked, then said that the Chinese central bank and pension funds around the world are less likely to buy now, in part because the real return that bonds offer when inflation is taken into account has gone down a lot.
“We had a 40-year bull market in bonds,” Dalio said. “Everyone who owned bonds caused the price to go up, and this kept the price going up for 40 years.” “Now the bonds are giving you negative real returns…and they are going down.”
When asked if “cash is still trash,” Ray Dalio’s signature saying, he said that holding cash is still “a trash investment” because interest rates aren’t high enough to fully offset the effects of inflation. The real value of cash, though, depends on “how it compares to other things.”
Ray Dalio also said, “We’re in this “write down financial assets” mode.”
Ray Dalio said yes when asked if he was still optimistic about China, but he added that now is a risky time to invest in the world’s second-largest economy, which could lead to opportunities for long-term investors.
He said, “Asset prices are low.”
When asked what he thought about where markets might be going, Dalio gave a funny answer.
“There is a saying that goes, ‘He who lives by the crystal ball will eat ground glass.'”