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Gundlach Sees ‘Suicide’ Combo of Rising Deficits, Rates

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DoubleLine Capital CEO Jeffrey Gundlach pointed to the country’s “suicide mission” during a webcast on Tuesday, as deficits rise along with interest rates, a theme he has stressed previously. But he also said investment-grade bonds are in risky territory as they hit valuation highs.

“It’s very strange that we have a rising deficit so late in an economic expansion and what’s supposedly a good economy,” the “Bond King” said. GDP growth “is nominal at 5.5% year over year and real is 3.0%, so for the last year it has been a good economy. It’s very bad that the deficit is rising.”

The U.S. recorded a $100.5 billion budget deficit in October, up from $63.2 billion a year ago, according to a Bloomberg report earlier this week. This rising deficit is tied to tax cuts and increased spending, among other factors. In the past fiscal year, the budget gap hit $779 billion.

“When the deficit goes up, it’s stimulative to the economy. That’s good in the short term, but it’s borrowing from the future,” he said. With the federal government adding to its borrowing and the cost of that borrowing on the rise, the U.S. fiscal situation could turn into “a problem within five years.”

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If loans for Social Security are included, Gundlach explains, the national debt for the past year is roughly $1.3 trillion, representing about 6% of GDP.

On the five-year horizon, he notes, are about $7 trillion in Treasuries that are maturing with an average coupon of around 2%. This situation could add some $150 million of interest expense to the deficit in 2023, if rates keep moving higher as the Fed has planned.

Corporate Bond Issues

Gundlach also urged caution concerning U.S. corporate bonds. More than half of this triple-B-rated debt, he says, would have a below-investment-grade rating if it were assessed purely on leverage.

“A lot of sectors look rich, but the one that looks by far the worst and the worst are corporate bonds,” Gundlach said, adding that junk bonds will be quite “dangerous” in a recession.

If ratings companies were to trim investment-grade ratings to reflect these falling leverage ratios, the junk market would be flooded: “It’s hard to see how the high-yield market will absorb any significant downgrading of the investment-grade market.”

He also discussed sectors that are interest-rate sensitive, such as banks, homebuilders and cars. “We’re starting to see a real decline in home prices from the major areas,” Gundlach said, pointing to lower deductions for property taxes and state taxes in some places, as well as to rising inventories.

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