Ray Dalio does the math: Interest rates at 4.5% would sink stocks 20%

(Bloomberg) — Ray Dalio issued a gloomy forecast for stocks and the economy after hotter-than-expected inflation rattled financial markets around the world this week.

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“It looks like interest rates are going to have to go up a lot (toward the upper end of the 4.5% to 6% range),” the billionaire founder of Bridgewater Associates LP wrote in a LinkedIn post on Tuesday. “This will reduce private sector credit growth, which will reduce private sector spending and therefore the economy with it.”

A simple increase in interest rates to around 4.5% would cause almost a 20% drop in share prices, he added.

The interest rate market suggests traders have fully priced in a 75 basis point hike next week from the Federal Reserve, with little chance of a full percentage point. Traders expect the Fed rate to peak around 4.4% next year, from the current range of 2.25% and 2.5%.

Dalio noted that investors may still be too complacent about long-term inflation. While the bond market suggests traders expect an average annual inflation rate of 2.6% over the next decade, its “guesstimate” is that the increase will be around 4.5% to 5%. With economic turmoil, it could even be “significantly higher,” he added.

Dalio said the U.S. yield curve would be “relatively flat” while there was no “unacceptable negative effect” on the economy.

The deepening inversion of key curve measures – seen by many as a potential harbinger of recession – helped reinforce a more pessimistic view of economic activity among investors.

Investors, speculating that the Fed will tip the economy into recession next year as it struggles to contain inflation, already see policymakers easing rates in the later stages of 2023.

The S&P 500 is headed for its biggest annual loss since 2008, while Treasuries took one of their worst hits in decades.

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