Gundlach: Don’t Fear Fed Tightening
December 16, 2014
by Robert Huebscher
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Throughout the post-crisis period, collective wisdom among market forecasters has held that interest rates would rise. But low rates have persisted, proving those prognosticators “dead wrong,” in Jeffrey Gundlach’s words. Gundlach, founder and chief investment officer of Los Angeles-based DoubleLine Capital, spoke on a conference call with investors on December 9. A copy of Gundlach’s presentation is available here.
Gundlach, correctly contrarian in his interest-rate predictions, now believes the Fed will raise rates in 2015 but investors should not fear Fed tightening.
“The Fed is going to raise interest rates in 2015,” Gundlach said, “unless the data change.”
The Fed will base its ultimate decision on the health of the economy – and unemployment specifically. Gundlach believes we should expect a rate hike if monthly job creation continues to be at least 200,000.
The effects of a Fed rate hike will surprise many people, Gundlach explained. Long rates have been decreasing as talk of a rate hike has increased, and Gundlach stated that Fed actions could occur against a backdrop of a “massive flattening” of the yield curve.
“If the Fed raises interest rates,” he said, “the flattening trend would just continue.”
Interest rates will be driven by the interplay between market expectations and actual Fed policy. Let’s look at how Gundlach expects those factors to play out.
Looking back at prior tightening cycles
A raise in rates in 2015 will neither follow historical precedent nor occur for the usual reasons, according to Gundlach.
The Fed has typically raised rates shortly after the official end of the recession. But the current recession ended in June 2009, over four and a half years ago.
That could lead to problems, he said. Near-zero interest rates have driven speculative price increases in high-end assets, like Picassos and Ferraris, according to Gundlach, and rate increases could rapidly deflate those bubbles.
Normally the Fed raises rates for “fundamental” reasons when the economy has reached a healthy level. It had previously set targets of sub-6% unemployment and 2%-plus inflation; only the former target has been reached.
Gundlach said that if the Fed raises rates, it will do so for “philosophical” reasons. “They are just nervous about zero-interest-rate policy going on this long,” he said, “and not having tools to fight any future weakness in the economy. The Fed wants get off of zero, so at least they have the ability to ease down the line.”
Gundlach warned against anticipating a gradual rate increase should the Fed tighten. The last five tightening cycles involved 25 basis point increases at every Fed meeting. He believed it was unlikely that rate increases would be spread out over a two- to three-year period, as some people are expecting.
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