The U.S. Federal Reserve’s decision to increase interest rates is unlikely to make cash or bonds attractive to own, says Ray Dalio, co-chairman and co-chief investment officer of Bridgewater Associates, the world’s biggest hedge fund with over $150 billion in assets, in an exclusive interview with Fortune India.
With consumer price inflation close to a four-decade high of 7%, the Fed in its December meeting announced that it would wind down its quantitative easing programme (bond purchases) by March. The market is already anticipating that the central bank could also announce a rate hike around the same time — the first hike since the end of 2018 — followed by two more 25 basis points hikes later during the year.
Dalio believes that it is unlikely that the interest rate increases will bring cash or bond rates up to attractive levels relative to alternative investment returns. “The projected rate increases will not be adequate enough to make cash and bonds an attractive alternative, and neither will it be enough to curtail inflation. So, in relation to inflation there will still be negative returns in those assets even if there is a rate hike,” believes Dalio.
Following the Fed hawkish signal, the benchmark US 10-year T-bill hit a high of 1.9% — the highest level since January 2020 — before retreating to 1.83%. The strengthening of yields has spooked equity markets across the globe, including India. However, Dalio does not expect a steep fall in the markets for now. “Any significant downturn in the markets and economy is unlikely in 2022; though 2023 and 2024 should get progressively riskier,” tells Dalio.
Sharing his analysis of economic cycles, Dalio explains that, typically, a recessionary cycle leads to a lot of stimulation by central banks, resulting in an economic expansion that is followed by inflation. The price spike is then followed by tighter monetary policy that leads to a recession, and then the cycle repeats again. On average, the cycle lasts about seven years, but the length of them is determined by how much debt and money creation there is and how much slack capacity there is before production constraints are hit.
“When a huge amount of debt and money is created and constraints are hit sooner, inflation comes quicker. So, the tightening comes faster, and the cycle is shorter. That's what's happening. We are now in one of those more intense and shorter expansions,” adds Dalio.
The current calendar year will mark the beginning of the tightening phase of the cycle. “Traditionally, in such transition years, interest rate hikes do not knock over the market or the economy in a big way. The transition years are periods that almost nobody remembers. For instance, if you think of 2008, the financial crisis comes to mind, but you don’t know what happened during 2010-11. So, that’s how transitionary years are within a cycle. 2023 will probably be more difficult and 2024 will probably be much more difficult financially and economically,” reveals Dalio.
