Special Edition: Gundlach Disagrees With Mnuchin And Powell

On inflation and Fed policy, Jeffrey Gundlach disagreed with comments made by Treasury Secretary Steven Mnuchin and Fed Chairman Jerome Powell. But Gundlach’s views were in line with the consensus on those key issues – inflation will not spike dramatically higher and the Fed will continue with its planned rate hikes.

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Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, a leading provider of fixed-income mutual funds and ETFs. He spoke to investors via a conference call on March 13. Slides from that presentation are available here. The focus of his presentation was the DoubleLine Total Return Bond Fund (DBLTX).

Mnuchin said rising wages aren’t necessarily inflationary. “Of course they are,” Gundlach said, which prompted him to title his presentation “Inflation is Inflationary.” But he also said he doesn’t see any strong inflationary threats, with one exception.

“Wage increases – coupled with tariffs – would be inflationary,” Gundlach said.

Gundlach also cited a comment by Powell that if inflation rises above 2% to 2.5%, it would make it easier to cut rates.

“That makes no sense,” Gundlach said. Gundlach hypothesized that what Powell meant to say was that increased inflation would give the Fed the flexibility to raise rates, so it could lower them later.

Let’s look at Gundlach’s comments about the economy and the markets.

The key driver of capital allocation

The primary driver of Gundlach’s capital-allocation decisions is the outlook for recession. He said that he and his team look at a dozen or so indicators that predict the likelihood of a recession over the next year or so. None of them are signaling a downturn.

The leading economic indicators (LEIs) are now at six and rising, he said. But they have decreased every time prior to a recession.

“There is no sign of a recession in the next 12 months,” he said, adding that it is almost impossible for the LEIs to turn negative in the next several months, given how slowly they move.

Similarly, the purchasing manager indices (PMIs) tend to go below 50 prior to a recession, he said, but they are rising.

Gundlach said that all four of the indicators of business confidence he follows are at a very high level. Yet all decline prior to recessions.

The “granddaddy” of recession indicators is the high-yield spread to Treasury bonds, Gundlach said. That spread had “massive moves” of about 400 basis points well in anticipation of the last two recessions. Now, he said, high-yield spreads are rising a little bit, but not nearly enough to give a “scare signal.”

“All recession signals are flashing ‘no caution’,” Gundlach said.

The Fed and the deficit

Gundlach’s career has spanned a regime of progressively lower rates and shorter Fed chairpersons. The latter streak ended with Jerome Powell, who is as much as a foot taller than his predecessor, Janet Yellen, who is 5’3”. Gundlach cautioned against inferring that the streak of falling rates would end as a result.

He said that deficits have historically shrunk in non-recessionary periods and risen during recessions. “We are late in the economic cycle,” he said, “and it is unusual that the deficit is expanding.” He said that this is driven political reasons, and noted that the fact that we are adding stimulus “has never happened before.”

Deficit problems will move to the forefront by the end of this year, he said. The deficit is getting a lot worse and there will be “a lot of bonds supplied to the market,” he said. The supply of bonds was about $650 to $700 billion in 2017, he said. It will be $1.2 to $1.3 trillion in 2018, in addition to quantitative tightening (QT) as the Fed contracts its balance sheet, according to Gundlach. There could be another $600 billion in tightening, he added.

”If quantitative easing (QE) was a tailwind for financial assets, then QT must necessarily be a tailwind,” he said.

Read the full article here by Robert Huebscher, Advisor Perspectives