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Gundlach: Fed to Raise Rates ‘Until Something Breaks’

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Starting next week, the Federal Reserve is poised to begin a number of back-to-back interest rate hikes “until something breaks” in the markets, DoubleLine Capital CEO Jeffrey Gundlach said in a conference call late Tuesday.

“There’s starting to become a sequential type of Fed pattern,” the bond king explained. “It’s almost old school.”

“Confidence in the Fed has really changed a lot,” Gundlach said. “The Fed has gotten a lot of respect,” with the bond market listening to it now that the central bank looks more likely to raise rates on a consistent basis than in the recent past.

The Fed is widely expected to raise the benchmark rate 0.25 percentage points. The DoubleLine executive believes there will be another two or three rate hikes later in 2017.

The Fed has “no more excuses” about why it cannot raise rates, he says. “And the bond market is showing remarkable faith in the Fed.”

Gundlach doesn’t foresee a recession on the near horizon, though equities could eventually weaken as rates spike.

Curve Ahead?

“Clearly, the yield curve has been flattening since July and post-election,” Gundlach said. “But it’s nowhere near inverted, so there’s room to go.”

On Wednesday, U.S. Treasury yields moved up after news that private-sector hiring topped expectations, thus boosting the likelihood of a hike in rates next week.

Yields on the 10-year Treasury increased 5.2 basis points to 2.56%, which is the highest rate since Dec. 27.

“Sentiment is short positioning to support a rally, but we’re really going sideways,” he said.

For his part, the DoubleLine exec sees these yields moving “up a bit” and then down to 2.25%. “We are still looking at a rally below 2.25% and then [moving] towards 3%,” he stated.

Gundlach added that “2.60% could be the high, though we could go higher if we get through the dead zone.”

Acknowledging the enthusiasm for equities since the election of President Donald Trump, which he had predicted, Gundlach said: “There’s some animal spirits behind it.”

Still, he cautions, the peaking equity markets are likely to “succumb to higher Treasury yields should they begin to occur in the middle of the year as we expect.”

“Stocks can grind higher, until we see the 10-year really move higher,” Gundlach said.

The Shiller CAPE (cyclically adjusted price-to-earnings) ratio, he points out, is going higher: “It was not looking like this in ’07. It is not cheap.”

Downside on Europe

Gundlach is very bearish on European debt and equity, which he views as susceptible to issues tied to the possible breakup of the European Union and the continuing quantitative easing policies.

“There is a ton of downside on euro bonds,” he explained. “When it comes to German bonds, [going] short is a much smarter position than long.”

He is bullish, though, on Asian stocks, which he sees as being undervalued, and is also positive about emerging market debt.

“The real winner has been local-currency emerging-market debt … not dollar denominated,” Gundlach said.

“We like the emerging markets, and we like non-U.S. equities – Asia … not Europe. Yes, Europe is cheap but there’s lots of geopolitical risk there,” he explained.

As a strategic move for a rising-rate environment, he points to Treasury Inflation Protected Securities and bank loans.

As for gold, Gundlach repeated his view that investors are wise to hold some as a core position. “It’s up a bit this year and could move higher in the intermediate term,” he explained, pointing to its movement as being consistent in the near term with the U.S. dollar, “which isn’t getting stronger.”

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