DoubleLine Funds CEO says a hike in interest rates by the Federal Reserve is nearly certain next Wednesday, and that means crazy days are coming for investors, advisors, traders and others.
“It’s a different world when the Fed is raising interest rates,” the so-called Bond King said late-Tuesday during a webinar. “Everybody needs to unwind trades at the same time, and it is a completely different environment for the market.”
Gundlach says the markets are pricing in an 80% chance of a hike — most likely of 0.25% — while one survey says 100% of economists think this move should indeed happen.
“We’ve had shaky markets since September. It will be interesting to see if markets deteriorate further,” he explained.
Unlike Bill Gross of Janus Capital Group, the DoubleLine chief is against such a move given troubles in the market for junk bonds — down 6% so far this year as measured by the JNK ETF — and leveraged loans.
“We’re looking at some real carnage in the junk-bond market,” he said. “This is a little bit disconcerting that we’re talking about raising interest rates with the credit markets in corporate credit absolutely tanking. They’re falling apart.”
Other signs that it is not an optimal time to raise rates include low inflation, weak manufacturing data and a slowdown in profit margins.
While Gundlach says it’s possible that the Fed will “pull another Lucy and the football,” referring to the Peanuts cartoon character who yanks the ball from would-be kicker Charlie Brown, he thinks it is more likely that Fed will go ahead with the rate hike.
“It’s like a George W. Bush [in Iraq] and ‘Mission Accomplished.’ It’s a bit premature … but the Fed wants to put up the banner. And very soon after, if they do it, we will have chatter about the next hike,” he explained.
“Within the Fed’s logic — and they’ve said it’s enough — the [stock] market is still close to its highs, and the dollar is moving sideways. So, the coast is clear to do it,” Gundlach said. “And while the [stock] market [overall] is not freaked out that much yet, there are plenty [of market indicators] that are.”
What would cause the Fed to keep rates steady? “There’s a chance they won’t raise, and it’s completely dependent on the markets,” Gundlach said.
Foreign equity and overall credit markets have “deteriorated in substantial ways,” Gundlach said. LIBOR, for instance, has moved up about 15 basis points in recent weeks “anticipating a Fed rate move,” he adds.
Watch out for the Federal Open Market Committee to announce its decision next Wednesday, Gundlach cautioned: “Almost certainly, we are going to see a lot of movement in the markets.”
As for why hiking rates now doesn’t make sense, Gundlach said that past hikes have taken place when quarterly gross domestic product growth was at 3% to 4.5%.
“We are below 2%, … and nominal GDP [growth] is not at all saying this is the moment,” he said.
The issue for the Fed, the fund manager says, is that it “has been saying forever that it was going to raise rates in 2015. It’s now got one last chance.”
The performance of the manufacturing sector “is at its lowest level since the Great Recession,” Gundlach said. “And with a hike, we get further downward pressure on nominal GDP … Manufacturing is not doing well given what’s happening in the global economy, especially in China.”
Once the Fed starts raising rates, it won’t be easy to switch paths, he notes: “It takes about 18 months for banks to reverse, and our problem is a lack of global growth … The Fed could be in a conundrum 12 to 18 months from now.”
The Fed has laid out numerically (and graphically) where it is going with rates, which Gundlach refers to as “their dots.”
“If they raise to 1.38% in a year, how can it be gradual and peaceful, given their dots? It does not sound gradual to me … up to 1.38% for the fed funds rate. Where would the two-year Treasury be?” he asked.
The Fed’s message seems contradictory to him: “What happens to the dots? They must come down for the Fed to define the rate rise as gradual.”
If the federal funds rate goes to 1.38%, that could mean “mid-2s for the two-year Treasury. And then, I’ve got the feeling that the yield curve will invert,” Gundlach said.
“The long bond is getting a bit happy with [the expected] rate hike,” he added. “It is rallying. It has respected the carnage of emerging market equities, commodities, junk bonds and bank loans.”
While following this data is uncomfortable and may cause some “jaws to drop,” Gundlach says, his “favorite chart” — found on slide 27 out of the 73 he went through during the conference call — highlights the decline in net profit margins for S&P 500 companies.
“Stress has been building up,” he said, “and this one can make you stay up and worry.”
— Check out Don’t Expect Higher CD Rates When Fed Hikes: Bankrate on ThinkAdvisor.