Ray Dalio says the Fed faces a tough balancing act

As the US Federal Reserve implemented its first interest rate cut since the start of the Covid pandemic, billionaire investor Ray Dalio signaled that the US economy still faces an “enormous amount of debt”.

The central bank’s decision lowers the federal funds rate to a range of 4.75% to 5%. The rate not only determines short-term borrowing costs for banks, but also affects various consumer products such as mortgages, auto loans and credit cards.

“The Federal Reserve’s challenge is to keep interest rates high enough to be good for the lender while keeping them not so high as to be problematic for the borrower,” Bridgewater Associates founder told Squawk Box Asia ” from CNBC. ” on Thursday, noting the difficulty of this “balancing act”.

The US Treasury Department recently reported that the government spent more than $1 trillion this year on interest payments on its $35.3 trillion national debt. This increase in debt service costs also coincided with a significant increase in the US budget deficit in August, which is approaching $2 trillion for this year.

On Wednesday, Dalio listed debt, money and the business cycle as one of the top five forces influencing the global economy. Expanding on his view on Thursday, he said he was generally interested in “the enormous amount of debt that is created by governments and monetized by central banks. These sizes have never existed in my life.”

Governments around the world took on record debt during the pandemic to fund stimulus packages and other economic measures to stave off a collapse.

When asked about his outlook and if he sees a credit event coming, Dalio said no.

“I see a big depreciation in the value of that debt through a combination of artificially low real rates, so you won’t be compensated,” he said.

While the economy “is in relative balance,” Dalio noted that there is an “enormous” amount of debt that needs to be rolled over and also sold, new government-created debt.

Dalio’s worry is that neither former President Donald Trump nor Vice President Kamala Harris will prioritize debt sustainability, meaning those pressures are unlikely to ease regardless of who wins the next presidential election.

“I think as time goes on, the path will be more and more towards monetizing that debt, following a path very similar to Japan,” Dalio posited, pointing to how the Asian nation has kept interest rates artificially low, what he depreciated the Japanese yen and decreased its value Japanese bonds.

“The value of a Japanese bond has fallen by 90%, so there is a windfall tax, artificially giving you a lower return every year,” he said.

For years, Japan’s central bank stuck to its negative rate regime while engaging in one of the world’s most aggressive monetary easing exercises. The country’s central bank only recently raised interest rates in March of this year.

Additionally, when the markets don’t have enough buyers to take on the debt, there could be a situation where interest rates need to rise or the Fed may have to step in and buy, which Dalio believes it would do.

“I would see (the Fed’s intervention) as a very significant negative event,” the billionaire said. The debt surplus also raises questions about how it is being paid.

“If we were in hard money terms, then you would have a credit event. But in fiat money terms, you have the purchases of that debt by the central banks, the monetization of the debt,” he said.

In this scenario, Dalio expects markets to also see all currencies fall, as they are all relative.

“So I think you would see an environment very similar to the environment of the 1970s, or 1930-1945,” he said.

For his own portfolio, Dalio says he doesn’t like debt assets: “so if I’m going to take a tilt, it would be underweight in debt assets like bonds,” he said.