(Fox Business) - The stock market is not pricing in the possibility of the Federal Reserve raising interest rates to a "very harmful" level and could be in store for a sharp correction in 2023, according to billionaire investor Ray Dalio.
The Bridgewater Associates founder said Wednesday that inflation could settle somewhere around 4% or 5% – well above the Fed's preferred target of 2%. Should that happen, he warned that the U.S. central bank will have to raise interest rates to a range approaching 6%.
"The Federal Reserve will put the short-term rate up towards that level, which is very harmful, very damaging to the economy," Dalio said during an interview with Business Today.
He added, "But what the Federal Reserve is trying to do is balance those, having an interest rate that's high enough for the creditor but not so high for the debtor. And so, what you're going to see is a slowing of the pace of the rise but still approaching over 5%, probably in the vicinity of 5.5%. This will still have an effect on all markets, particularly stocks."
The S&P 500 has already plunged more than 4% 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 almost 1,000 points, while the tech-heavy Nasdaq Composite has tumbled about 5%.
Dalio previously warned that higher interest rates could trigger a 20% decline in equity prices based on the present value discount effect. In addition, there would be another 10% negative impact from declining incomes, he said in September.
The Fed has embarked on the most aggressive tightening campaign since the 1980s as it tries to wrestle under control inflation that's still running near a 40-year high. The current benchmark federal funds range of 3.75% to 4% is well into restrictive territory, and the Fed has shown no signs of pausing as inflation remains abnormally high.
Although policymakers indicated a preference for a smaller, 50-basis-point rate hike at their meeting next week, they have also signaled an appetite for a higher peak interest rate that could further restrict economic activity.
Fed Chairman Jerome Powell said rates are likely to reach a "somewhat higher" level than policymakers initially forecast in September, when they projected a median rate of 4.6% in 2023.
"The time for moderating the pace of rate increases may come as soon as the December meeting," Powell said during a speech in Washington last month "Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation and the length of time it will be necessary to hold policy at a restrictive level."
By Megan Henney
