Bridgewater Associates founder Ray Dalio has joined veteran bond manager Bill Gross in predicting a major bear market for bonds. In an interview with Bloomberg’s Erik Schatzker, Dalio warned that a rise in bond yields could lead to the biggest crisis in fixed income markets in almost 40 years. 

If you recall, a couple of weeks ago both Bill Gross and Jeff Gundlach, two of the most famous bond fund managers, spoke of the prospect of a bond bear market coming. And Bill Gross refined his call by writing how the bond bear had actually begun post-Brexit in 2016. Dalio is adding significantly to the bearish sentiment here, as he says explicitly that he agrees with Gross that the bottom for bond yields is behind us.

Here’s the quote to remember:

“A 1 percent rise in bond yields will produce the largest bear market in bonds that we have seen since the 1980-81 period.”

And by this, the hedge fund veteran meant that percentage changes in bond prices are more extreme at low-interest rate levels. A 1% rise in rates when base rates are 1.5% will have a much greater effect on price than when interest rates are 4 or 5%.

If you listen carefully to what Dalio is saying with his analogy of driving behind the central bank truck, he is implying that it may be difficult for a central bank to slow the economy down when it is running at high speed without causing a pile-up behind it. Dalio tells Schatzker that he expects the boom before the bust to last 12 to 18 months. And when the Fed is forced to tighten, Dalio says it will do so more aggressively than markets are pricing in, even more aggressively than the Fed has forecasted.

My view: I am not convinced we are going to see a bond bear market, at least one that is long-lasting. And that’s because a bond bear market will necessarily negatively impact credit growth, precipitating a recession. This is negative for inflation and bullish for bonds. So while the initial move might be bearish, if it does indeed create crisis conditions, it will force yields lower, a lot lower.

Dalio says the next recession will be worst for the middle classes and the poor. He warns that, even now, with the economy operating at its best in a decade, we have populism fuelled by social unrest — the implication being that the problem will be worse politically when the economy turns down.