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Equities may see a 20% decline if rates rise to around 4.5%: Ray Dalio

The inflation rate will stay significantly above what people and the Fed want it to be, that interest rates will go up, other markets will go down, and the economy will be weaker than expected.

Equities may see a 20% decline if rates rise to around 4.5%: Ray Dalio
It looks like interest rates will have to rise a lot and there could be a significant fall in private credit that will curtail spending.

Ray Dalio has a piece of bad news for the US economy and the stock market investors. Ray Dalio whose net worth is close to $16.2 is talking of a market crash. In a recent LinkedIn note, Dalio, Founder, Co-Chief Investment Officer, and Member of the Bridgewater Board sounded murky on the economy and markets. The inflation rate, Dalio writes, will stay significantly above what people and the Fed want it to be (while the year-over-year inflation rate will fall), that interest rates will go up, other markets will go down, and the economy will be weaker than expected.

One thing he is clear about is that it all starts with inflation and goes on to explain how inflation, interest rates, markets, and economic growth relate to each other and what that means for what’s ahead.

Dalio estimates inflation to 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. This is how US inflation moved over the last 4 months – From 8.6% in May, US inflation rose to 9.1% in June and later fell to 8.5% in July and finally settled at 8.3% in August 2022.

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If the assumptions and estimates about inflation and real yields fall in place, Dalio expects both long and short rates to be between 4.5 and 6 percent. In 2022, Fed has raised rates by 225 bps. There have been consecutively two rate hikes of 75 bps. The interest rate paid on reserve balances was raised to 1.65 percent, effective June 16, 2022. The federal funds rate was to be maintained in a target range of 1.5 to 1.75 percent. Later on, the interest rate paid on reserve balances was raised to 2.4 percent, effective July 28, 2022. The federal funds rate was to be maintained in a target range of 2.25 to 2.5 percent. It remains to be seen how much Fed hikes the rate on September 20-21 FOMC meeting.

Dalio in the note writes, “I think it looks like interest rates will have to rise a lot (toward the higher end of the 4.5 to 6 percent range) and a significant fall in private credit that will curtail spending. This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.”

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As the era of easy money and liquidity ends and with mounting pressure on the economy, the impact on the stock market is already visible. S&P 500, Dow 30 and Nasdaq Composite are down by 17%, 14% and 25% year-to-date. “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,” writes Dalio.

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