Billionaire Ray Dalio, the founder of one of the world's largest hedge funds, warned that stocks could tumble even lower this year after the hotter-than-expected August inflation data rattled markets this week.
"It looks like interest rates will have to rise a lot (toward the higher end of the 4.5% to 6% range)," the Bridgewater Associates founder wrote in a LinkedIn article on Tuesday. "This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it."
The S&P 500 has already plunged more than 6% this week as concerns over sky-high inflation, rising interest rates and a darkening economic outlook continue to weigh on the market. The Dow Jones Industrial Average, meanwhile, is down more than 1,800 points, while the tech-heavy Nasdaq Composite has tumbled about 1.7%.
If interest rates climb to 4.5%, it would trigger a plunge of about 20% in equity prices based on the present value discount effect, Dalio said. In addition, there would be another 10% negative impact from declining incomes.
The current benchmark federal funds range of 2.25% to 2.50% is around the "neutral" level, meaning that it neither supports nor restricts economic activity. However, Federal Reserve Chairman Jerome Powell has suggested that a restrictive stance will almost certainly be necessary as the central bank tries to pump the brakes on the economy.
One reason that Dalio thinks interest rates will climb so high this year is that he believes the market is severely underestimating where inflation will end up. While the market expects inflation to hover around 2.6% over the next decade, Dalio estimated the real rate will be closer to 4.5% to 5%, barring any major economic shocks.
"The upshot is that it looks likely to me that the inflation rate 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, that other markets will go down, and that the economy will be weaker than expected, and that is without consideration given to the worsening trends in internal and external conflicts and their effects," he wrote.
Dalio's comments come just a few days after the Labor Department reported the consumer price index for August came in hotter than expected. Prices rose 0.1% on a monthly basis and 8.3% year over year, dashing analysts' hopes for a monthly decline.
Stocks fell sharply on Tuesday after the surprisingly hot report on fears of an even more aggressive Fed, with the Dow sliding 1,276 points – the worst day since June 2020.
Investors are already bracing for the Fed's policy-setting meeting next week, which is slated to take place Sept. 20-21. Traders are betting on officials approving another super-sized, 75-basis-point rate hike – the third of its kind this year – at the conclusion of the meeting, although some on Wall Street think that central bankers could go even bigger with a full point increase.