The Federal Reserve faces a conundrum: It does not want interest rates to fall, but it does not want the U.S. dollar to rise.
“If the dollar goes higher, the Fed is not likely to raise rates,” said DoubleLine Capital CEO Jeffrey Gundlach, on a call with investors Tuesday afternoon.
“Clearly the Fed is cognizant of [the impact of] the strong dollar, and that gave the short-term yield curve a bit of a boost recently,” he explained. “If the dollar rises further, maybe the Fed stays on hold. It could be.”
For companies that sell goods overseas, the higher dollar can weaken sales and thus negatively impact corporate earnings.
“The dollar’s rise has to have consequences,” said Gundlach, who is also DoubleLine’s chief investment officer, noting that he doesn’t see it going up further in the short term.
If the U.S. currrency softens, the Fed “can relax, and then it would raise rates, and then the dollar will [get] stronger [again],” he explained. “It’s a tug of war, so the dollar should not make much progress in the short-term.”
If the Fed raises rates, for instance, three times by year-end, “We will see it is a mistake ..,” Gundlach stated. “If the Fed raise rates as forecast, it will have to reverse course. I think it’s too much.”
As for other market trends, the fixed-income specialist says liquidity in the bond market is “now reasonably high.”
He’s generally steering clear of investment-grade corporate bonds due to high valuations, but is positive on municipal bonds thanks to their high yields. “Municipals are fairly valued and have gotten cheaper in the past few months,” he noted.
As for high-yield bonds in the short run, they are fairly valued compared with where they were in January 2014, when they “were the most overvalued in history,” the CEO says.
Still, he recommends investors “stay tuned,” because it’s “very unlikely that corporate growth will be uniform [going forward], and we could see problems.”