Gundlach: The Fed’s Biggest Problem
December 14, 2015
by Robert Huebscher
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The Fed may be intent on raising interest rates, but a wide range of market indicators should give it pause to reconsider, according to Jeffrey Gundlach. Indeed, he said the biggest challenge to a rate hike is the weak inflation readings in the U.S.
Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital. He spoke to investors via a conference call on December 8. Slides from that presentation are available here. The focus of his talk was DoubleLine’s flagship total-return mutual fund, DBLTX.
“The Fed’s biggest problem in justifying the rate increase is the inflation numbers make this anything but the moment to act on raising interest rates,” he said.
And the Fed faces other problems.
In an eerie premonition, Gundlach said that, “It will be interesting to see if the meeting can come and go without the market deteriorating further.” He noted that, “We are looking at some real carnage in the junk bond market.”
Three days later, the high-yield market was rocked by the gating of Third Avenue’s high-yield fund, followed by a similar move by Stone Lion Capital Partners, a distressed-debt hedge fund.
I’ll look the problems in the junk bond market. But first, let’s look at the range of indicators that Gundlach said argue against a rate increase, as well as a few that point in the other direction.
The landscape facing the Fed
On the day Gundlach spoke, there was an 80% likelihood of a rate increase, based on data from the capital markets. Moreover, he said that 100% of economists are predicting an increase. If there is an increase, Gundlach said it would be 25 basis points – no more, no less.
Looking at the historical data, Gundlach said that real GDP growth and unemployment are consistent with levels at past increases.
But nominal GDP is not consistent with prior rate increases. Gundlach said nominal GDP growth is lower than it was in September 2102, when the Fed considered the economy so weak that it began its third round of quantitative easing (QE3).
Gundlach called the ISM survey data a “disaster.” It is at its lowest level since the Great Recession. That weakness is confirmed by industrial production, which Gundlach said is flat on a year-over-year basis. The ISM is highly correlated to nominal GDP, he said, and the implication is that a rate hike would put “downward pressure on nominal GDP.”
European policy contrasts bluntly with a rate increase. Inflation is lower in the U.S. than in Europe, he said, if one compares the data on an equivalent basis. U.S. GDP growth is a mere 60 basis points greater than in Europe, which Gundlach said exposed an inconsistency between Europe’s aggressive quantitative easing and a Fed rate hike. “There is just something seriously wrong with this picture,” he said.
Lack of inflation worries Gundlach the most. He called it a “bugaboo that is affecting the markets right now, and may cause a problem for the Fed.”
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