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Washington | Bridgewater founder Ray Dalio says central banks around the world will have to start cutting interest rates again in two years in an effort to rebuild their economies following a damaging bout of stagflation.
In an interview with The Australian Financial Review, the billionaire founder of the world’s biggest hedge fund manager said stagflation – low growth and high prices – would end up hurting the US economy so much that central banks would have to cut rates again in 2024, the year of the next presidential election.
“We believe that we are in a tightening mode that can cause corrections or downward moves to many financial assets,” he said.
“The pain of that will become great and that will force the central banks to ease again, probably somewhere close to the next presidential elections in 2024.”
His comments come amid surging inflationary pressures around the world, driven by a perfect storm of post-pandemic supply chain disruption, an energy crisis fuelled in part by the Ukraine war, and a broad consumer recovery.
The US Federal Reserve has lifted interest rates twice this year and is expected to tighten further in its bid to cool demand and so tame inflation, which is running at a 40-year high.
The Reserve Bank of Australia on Tuesday increased rates for the second time this year, by 50 basis points to 0.85 per cent, and is tipped to lift the cash rate further to 1.35 per cent in July.
Structural inflation
In the US, financial markets are pricing in another two half-a-percentage-point rate rises this month and next month, and banks such as Morgan Stanley expect the Fed to keep tightening monetary conditions until its official funds rate hits 3.125 per cent, up from its current 0.75 per cent to 1 per cent range.
However, in the US and around the world, the risk is that prices remain high as economic growth ultimately slows and jobs are shed – a classic case of stagflation.
Morgan Stanley’s models put the chance of recession at 35 per cent, from just 15 per cent earlier in the year.
Mr Dalio, who raised the prospect of sustained inflation last year, told the Financial Review: “It is a structural inflation situation that is going to produce stagflation.”
He ascribed stubbornly high inflation to continued spending by governments and corporations, with diminishing returns in both cases.
“There is going to be a great deal more spending than there will be earnings. There will be deficits. That will continue for a long time and for that reason, we don’t want to be in cash or bonds,” he said.
“There are assets to hold during a tightening and there are assets to hold during an easing. And in both cases, right now, we don’t want to own debt assets. We favour inflation hedged assets.”
He said inflation was quickly making many fixed-income assets unprofitable, and this would ultimately feed into the inflation spiral.
“The debt that’s being held as assets by bondholders, and by holders of money market funds, will have a significantly negative return after adjusting for inflation,” he said.
“And that causes them to want to sell that debt and move him into other assets have a better return.”
“And that produces a big supply-demand imbalance, which causes either real rates to rise a lot, which causes an economic and market downturn, or the central bank has to print more money to make up for that supply demand.”
Bridgewater told investors in April that since the end of March 2020, its top asset class investment in terms of share of gross returns had been commodities, which yielded 17 per cent.
Mr Dalio’s latest outlook came as the World Bank raised the spectre of stagflation in its global outlook on Tuesday (Wednesday AEST).
World Bank Group president David Malpass said the “risk of stagflation” was already “hammering growth” and that for many countries, “recession will be hard to avoid”.
The World Bank cut its global growth forecast from 5.7 per cent last year to 2.9 per cent this year – significantly lower than 4.1 per cent that was anticipated in January.
