While markets have fallen in response to rising inflation and interest rates, a sharper decline is still to come, according to Bridgewater founder Ray Dalio.
“When interest rates go up, asset prices go down,” Dalio said Thursday. “The assets have gone down reflecting the interest rate adjustment but not down reflecting the contraction. There’s a lot more to come.”
Dalio shared his views on the market and politics at the Forbes Iconoclast Summit held Thursday in New York City.
His commentary follows the Federal Reserve’s decision to raise rates by 75 basis points on Wednesday, in line with expectations. The Federal Reserve has raised rates by 3.75 percent over the past 12 months.
To avoid a “significant stagflation environment,” Dalio noted the central bank would need to balance between inflation and interest rates. “And they’re doing it,” he said.
Inflation in the United States has risen 8.2 percent in the past 12 months. While the Federal Reserve’s long-term inflation target is 2 percent, Dalio predicted that the central bank will go for a more realistic target of around 4.5 to 5 percent.
Based on those numbers, he believes the real interest rate could land in between 4.5 percent and 6 percent. “Six starts to break things pretty bad,” Dalio said. “The vicinity of 4.5 and 6 may be the number in terms of cracking the thing.”
In addition to these economic concerns, Dalio also addressed political concerns including include the rise in populism in the United States and conflicts abroad. The way Dalio sees it, the United States is already engaged in a trade war, a technology war, a geopolitical and influence war, and a capital and economic war. He thinks a military war is a possibility, but that has yet to come to fruition.
To cope with all of this uncertainty, Dalio said investors need to focus on real, rather than nominal returns, incorporating both inflation and taxes into their calculations.
“Everybody is thinking about nominal,” he said. “They think cash is safe because it doesn’t move much. As you start to think about what the real return is, that changes.”
The hedge fund billionaire pointed to inflation index bonds as one interesting investment right now, though he said the timing is important.
“At the end of the day, you have to look at the inflation hedge,” Dalio said.