Jeffrey Gundlach, the CEO and chief investment officer of Doubleline, has a message for all those advisors and investors who think the Federal Reserve will raise rates in December: Take more interest rate risk and less credit risk. Buy long-term Treasuries, and sell high-yield bonds.
It’s a money-making strategy when the Fed does raise rates, according to Gundlach, who was featured in a webinar, “The Road Ahead: What’s Next for Fixed Income,” on Tuesday, along with James Ross, global head of SPDR Exchange Traded Funds.
Gundlach recalled that beginning in 2013, confidence was growing that the Fed would hike rates, but despite that, long-term Treasury yields fell throughout 2014. Thirty-year Treasury bond yields plummeted, ending 2014 at 2.70%, down from 3.93% at the beginning of the year. By year-end the 30-year Treasury bond had gained almost three times more than the S&P 500: up 30% compared with 11.4%. Ten-year Treasury yields also fell sharply to 2.21%, down from 3%.
“The long bond wants the Fed to tighten,” Gundlach said.
Gundlach said that he was buying the 10-year Treasury note earlier this year for the SPDR DoubleLine Total Return Tactical ETF (TOTL) and Total Return mutual fund (DBLTX) when Treasury yields his yields rose above 2.25% from around 1.65% in January, then stopped when yields fell back to 2%. The 10-year Treasury yielded 2.21% at Monday’s close. Gundlach doesn’t expect the Fed will raise rates this year.
The market is split. Traders are now pricing in a 49% probability of a Fed rate hike at the central bank’s December policymaking meeting (there’s a meeting also in October), down from 64% just before the Fed’s most recent two-day meeting, which ended last Thursday, according to Bloomberg.
Gundlach says the market is more confused now about Fed policy than it was before last week’s meeting.
Before the meeting “the market thought the Fed had a framework to raise rates but now … there is more uncertainty,” Gundlach said. Fueling the uncertainty, Gundlach said, is what was said in the Fed’s policy statement and Federal Reserve Board Chair Janet Yellen’s press conference afterward about global economic developments and inflation expectations.
The statement noted that :recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
Yellen stressed that point in her press conference noting that “in light of the heightened uncertainty abroad, and the slightly softer expected path of inflation, the committee judged it appropriate to wait for more evidence including some further improvement in the labor market to bolster its confidence that inflation will rise to 2% in the medium term.”
These statements have “has created a little bit of a vacuum,” said Gundlach.
In addition, he cited a recent Goldman Sachs report that said the recent decline in equity prices has already tightened financial conditions. Gundlach contends, as he has before, that there is no reason for the Fed to raise rates this year. “The financial conditions to do so are not in place,” said Gundlach, and he listed four reasons why:
- Commodity prices are at their lowest levels in more than a decade, indicating little inflation, and the Fed’s favorite inflation indicator, the PCE deflator, isn’t rising.
- U.S. nominal GDP growth is at 3.7% year over year, far below the usual nominal GDP when the Fed has tightened in the past. Since 1948, the Fed has tightened 118 times and 112 of those times the nominal GDP growth was at least 5.5%, said Gundlach.
- Junk bond prices are near a four-year low, as illustrated in the SPDR Barclays High Yield Bond ETF (JNK), suggesting that the economy is not as strong as some might think.
- Emerging market equities are trading at six-year lows, as seen in the iShares MSCI Emerging Markets Income ETF (EEM).
In addition, Gundlach cited a recent Goldman Sachs report that noted that recent decline in equity prices has already tightened financial conditions, essentially doing what a Fed rate hike would do.
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