Bond market commentary tends to be a dry affair. But over the years Jeffrey Gundach, founder and CEO of the $140 billion bond-focused investment firm DoubleLine, has earned a reputation for talking about the intersection of financial markets and national politics in a trenchant, useful, and entertaining way. Put his name into Google News and you’ll see a scroll of headlines chronicling nearly every public utterance. In a world where financial markets have become very political — often more responsive to the cues and directives of central bankers and politicians than old-school economic fundamentals — his casual, cross-disciplinary mode of analysis feels particularly apposite.
Gundlach’s willingness to make audacious predictions also doesn’t dampen his media appeal. Last year, after a string of remarkably accurate calls about financial markets, he went way out on a limb about where interest rates were headed. “Gundlach Sees 6% Yield in Three Years. Anyone Else?” blared a Bloomberg headline. At the time, the ten-year bond (the subject of his call) was at 3 percent. Today, it is well under 2 percent — a huge move in the other direction. At the moment, it sure looks like a monumental miss, but, as he describes in the interview below, Gundlach still considers a world of much higher rates one of two reasonable scenarios. (Gundlach used the same two-possible-roads logic to recommend a volatility-based trade at the high-profile Sohn conference this year, and that paid off in a big way.)
If he’s close to the mark on the rest of his analysis — expecting that 2020 could see recession, election chaos, and the beginning of a debt crisis — the next 16 months won’t be boring.
Trump seems to have set himself the difficult two-part task of both to waging a trade war with China while trying to keep the U.S. economy from slipping into recession. What do you make of his strategy?
I think maybe he’s playing a dangerous game of intentionally weakening the economy so the Fed cuts rates and monetary easings work with a lag. Cutting rates now would probably be beneficial in the summer of next year, ahead of the election. Also if you put on tariffs, or scare consumers, then maybe you can take the tariffs off and you’re moving consumption from today until 2020.
So you think he’s trying to engineer a brief economic dip and a rate cut — and then trusting things will rev back up again next year before election day?
That’s potentially a strategy. As I say, it’s pretty dangerous. It’s hard to time the economy by, you know, blunt instruments. I don’t know, it seems like he’s working really hard to get the Fed to cut rates — and the bond market is certainly helping. You know the bond market is telling the Fed they’re completely on a different planet.
The amazing thing is Jay Powell — poor guy. I feel sorry for him because every meeting, he’s gotta totally change his messaging, ever since December. Every meeting is totally different. And that “mid-cycle adjustment” thing that he pulled out at the end of July? That was just a horrible idea. Nobody knows what that really means. But it makes it sound like you’re really intending on really hiking again.
It seems like neither the stock market nor the bond market has quite recovered from Powell uttering that phrase at his press conference.
Yeah, well, stock markets peaked basically that day. Every time Powell gets in front of the press-conference microphone, the Dow drops a thousand points.
So are we headed into a recession in the next year or so?
I give a 75 percent chance of recession prior to the election and have for months. I know that the markets and the rhetoric has come around to something close to that — but when I first said it, people thought I was crazy. But now CEO surveys are getting a little bit shaky. CEO confidence is declining pretty sharply. It’s not at a recessionary scare level quite yet, but two thirds of CEOs surveyed expect a recession before the end of 2020 so that’s pretty close. I use the election as the end date but it’s about the same thing. The Fed model also shows pretty high probability now of a recession if you put it in the context of data since 1985.
You were, in fact, one of the first public figures to predict a Trump victory four years ago. If you’re expecting a 75 percent chance of a recession, how do you see the 2020 election cycle playing out?
Ah, yes. I’m glad you brought that up. The first time I publicly predicted Trump would win was in the Barron’s roundtable, which was the first Monday in January 2016. And Trump at that point was like 500-to-1 or something in the betting odds — but I was absolutely sure he was going to win. I went through the candidates and … people wanted the dishes to get broken, you know?
But I can’t even imagine Trump running for reelection if there’s a recession in the summer of next year. I don’t understand what he could run on.
Wow. That would be dramatic. Do you think the GOP would do a sort of last-minute reboot?
Trump could pull a Lyndon Johnson and just say, I’m not running. Because he’d probably know he was going to lose. And you know, Trump doesn’t want to lose. That’s his reason for not running, he could do the most ridiculous thing ever. He could actually say in the midst of a recession, “I’ve completed my mission of making America great again, there’s no work left to do, so there’s no point in me running.”
“I’m going to go start the Trump News Network — see you suckers later”?
That could happen. I also still think there’s a fair chance that there could be three candidates that have funding, and you could have a three-way race in 2020. I have the suspicion that we’ll see somebody new in this race. Bloomberg started to do interviews in the last couple weeks — which is interesting. I don’t know if that’s just because he’s bored or what’s going on. In those interviews he categorically states that he’s not running for president, so it’s probably a stretch to think that this is some sort of a ramp-up phase. But if he’s going to run as an independent, he better file right now. If he’s going to run as a Democrat, he’s got more time – he can wait till Biden’s candidacy collapses or until, you know, something else odd happens.
Also, I think Hillary … she could show up. She really could.
The betting markets still have Hillary at like four cents on the dollar to win the Democratic nomination. That’s pretty low – but admittedly higher than any of the other notional or celebrity candidates.
It’s also way higher than Beto O’Rourke. I think he’s at one cent. There are many that are at one cent but it’s not real, because you can’t get anybody to take the other side of the trade. Like Gillibrand — nobody will actually bet on her. You can’t short her. You can short Beto — people will actually give you the one cent. And I wish I could do that trade in like a billion-dollar size. Because to short Beto O’Rourke just seems like absolutely free money.
Let’s come back to the economy. What does the big picture look like to you?
Last year, the national debt increased by over 6 percent of GDP. And nominal GDP growth was 5 or 5.1 percent. So all of the growth of the economy basically can be ascribed to debt. Another way to put it is if we hadn’t increased the national debt at all and just kept it the same, there would’ve been no economic growth. There would’ve been a negative sign. Which means there’s no organic growth in the economy.
What does that say about this economic expansion, which is now a decade old?
It’s a debt-based expansion. And look at corporate debt. Corporate debt is triple the size it was in 2006 before the great recession. I mean it’s just massive.
Where do you see the stock market going between now and, say, the presidential election next year?
Well, the history books I believe will say the peak of the super cycle in global stock markets was January 26th 2018 — so, that’s 18 months ago. The world index is substantially lower than it was at its peak on that day. The broader U.S. stock market is also lower than it was January 26, 2018. The falsest narrative out there currently is how the U.S. is in a raging bull market for stocks — it’s completely untrue. Plus, if a recession comes, it’s completely nonsensical to think that you are going to see positive gains in earnings. So you should expect to continue to tread water at best in the U.S. equity market.
What about the bond market?
I think the bond market right now in the United States is very hard to predict, because given natural forces of free markets yields would be rising between now and the 2020 election. However, the Fed could very easily manipulate the yields, as has been seen in Japan and Europe, and they’ve made comments that they’re open to that idea. So, will bonds yield go to 5 or 6 percent? Or will they go to zero? It’s up to the Fed. And, based on what they’re saying, I would give the natural market being left to its own devices less than a 50 percent probability.
So where would you put your money?
I like gold for now, and I like T-bills. I mean it’s a very non-risky portfolio, but actually, that mix of assets would probably have outperformed the S&P 500 year to date.
What do you make of the inverted yield curve for two-year and ten-year Treasuries? That happened last week and has been reported by the media as a very ominous sign.
Um, it’s receiving far too much attention. The yield curve has been inverted for months now. The real inversion is the Fed funds rate being higher than every part on the yield curve. So it’s just arbitrary to worry about twos and tens. This thing that people woke up to last week is getting a lot of attention, but they’re missing a much bigger picture. The picture is that the Fed, with their positioning relative to bond investors’ positioning, has fully inverted the curve.
By keeping rates too high.
It looks like it! I mean it appears the December hike was pretty pointless, and now they have reversed it and the market is screaming for more. The thing that’s fascinating about this inversion is it’s inverted at such a low yield level.
I mean, it’s kind of shocking that anybody wants a ten-year bond yielding 1.5 percent when you could buy a six-month T-bill yielding two percent. I just find it remarkable.
So let’s say you’re right — those 75 percent odds hit and there is a recession before 2020. Setting aside politics, how do you see this recession shaping up?
Well, the fundamental thing that I think about is that we’re running a massive debt-based economy now during an expansion, where tax revenues went up by 3 percent in the first seven months of this year but spending went up by 8 percent. And that gap’s already widening. In recessions, obviously tax receipts go down and spending goes up — so what you’re looking at is an incredible increase in the national debt during the next recession.
The federal deficit typically increases to about 4 percent of GDP in postwar recessions. Look at the past two: The deficit went up to 6 percent of GDP in the ’02 recession and it went up to 8 percent of GDP in the ’08 recession. So, amazingly in the next recession, you can be talking about a deficit of $3 trillion.
Extrapolating that trend, you mean.
Three trillion dollars! And you know, certainly foreigners aren’t buying our debt anymore. China isn’t buying our debt anymore, so who’s buying the debt? It’s the public. So in a recession, how’s the public going to come up with $3 trillion to buy these bonds?
So maybe the Federal Reserve goes back to quantitative easing and follows Japan and the European Central Bank into the forever-monetization scheme of the debt. You know, in Japan, the government and the banks and insurance companies it regulates own over 90 percent of the bonds.
Do you think that’s where we’re headed — into a Japan scenario where we run huge deficits seemingly without end but the Federal Reserve just gobbles them up by buying up our own bonds and ballooning its balance sheet?
It’s very difficult, because this is a policy choice. If you told me that the Fed is not gonna do QE ever again, then I’d say interest rates would go up at the long end of the Treasury market by a fair amount. I mean, you have to attract capital. You have to attract savings into the bond market. Who’s gonna be all excited about a negative real yielding bond when there’s trillions of them being floated? You would need real interest rates to be at 2 percent or something and the yield on your longer bonds have to be… 5 percent? 6 percent? But that’s impossible because the interest expense would be outrageous.
If Treasuries were yielding 6 percent, interest payments would eat up a pretty big share of the federal budget.
Right. Well, based on the Congressional Budget Office’s projections, the interest expense on the debt — and they’re using conservative calculations — is going to be 3.25 or 3.5 percent of GDP within eight years. Lately it’s been around 1.25 percent. Well, think about that — if you suddenly have 2 percent more of GDP going to interest expense.
Here’s a big picture question I think a lot of people have: Japan’s debt is about twice as big as ours, compared to GDP, and they’ve held things together now for more than 20 years. Will we look back in a couple decades and see something similar? You know, interest rates permanently stuck below zero, huge debt, not much growth — but also no catastrophic crisis or reckoning?
Well, that’s an interesting question. Certainly it’s gone on for a long time in Japan, but their bonds, they own them all themselves. The U.S. has a fair amount of bonds that are owned by other people, and I’m not sure you can just cancel your debt on other people. You can always pay them back with monetized … you know, with fiat currency, I suppose. It is an interesting thought experiment. I don’t think anybody really knows the answer.
But I think this negative interest rate thing is ultimately fatal for the banking system. It just takes a long time. Every German bond is below zero. And a problem with that is that you’ve regulated your banking industry and your financial industry into owning these things. Look at Deutsche Bank’s stock. It is at an all-time low as we’re speaking here.
In a broader sense, this comes around to the question of modern monetary theory, which has started cropping up in a big way in American politics as a means of funding massive new policy initiatives. What are the limits on having the Fed monetize debt? Is there actually a point where inflation kicks in? It certainly seems to have been scarce for a long time, even as the federal debt and the Fed balance sheet have expanded massively.
Sure. You can make inflation kick in. I know very well how to make inflation kick in and that’s Universal Basic Income that you ratchet up to a high level. I mean, you started out with $1,000 dollars a month if you’re Andrew Yang, and then you just start spinning the dial. You make it $5,000 a month, $10,000 a month …
Yet the fact that the yield on the ten-year bond is well below 2 percent suggests the market isn’t all that worried about it.
But the whole yield curve is below the inflation rate. I mean the core Consumer Price Index came out at 2.2 percent year over year, and labor costs came out at 2.4 percent year over year. Average hourly earnings are growing over 3 percent. This narrative that we can’t get inflation at 2 percent is true if you look at, say, the personal consumption expenditure deflator, the core, down at 1.5, 1.6 percent or so. But there’s plenty of inflation indices that are over 2 percent. In fact the only one that isn’t is the PCE.
So this narrative that you can’t get to 2-percent inflation rate is odd. But it’s kind of a way for the Fed to not talk about tightening, thanks to what’s creeping higher on the inflation side. So I think the Fed pretty much understands that the debt issuance in the next recession is going to be completely impossible to place with United States citizenry. They have interest rates at this level, so they’re gonna have to figure out a way to, you know, get those bond yields manipulated.
Those two things would seem to be in tension — the market is demanding lower rates and yet you cite relatively healthy measures of inflation.
Yeah, I mean you’ve heard about a couple things that’ve happened that kind of indicate that the Fed is concerned about the coming debt burden. The first is after the December disaster at the press conference, suddenly they sent out all these ambassadors to say what they really meant to say, which was that quantitative easing is going to be considered a non-emergency, non-extraordinary type of a tool. So now it’s just going to be a normal thing. We don’t need a recession, we don’t need zero interest rates — it’s just one of these great tools we’ve developed for our tool kit.
Well that’s kind of telling you that they’re worried about the ability to float the debt in the next recession. And that also ties in with this talk about modern monetary theory — which essentially is to say that everything is okay as long as the economy is growing faster than the interest-rate level. I think what they really want is inflation to be higher than interest rates. Because if that’s the case then you’re extending out the timeline of problems based upon the successive indebtedness of the United States economy and global economy.
So how high does the Fed want inflation to be?
Remember when 2 percent was the Fed’s ceiling on inflation? Then remember when 2 percent became the goal on inflation? Now it seems like 2 percent is the floor on inflation — the hoped-for floor.
So they are nudging us toward 3 percent as the official inflation goal?
I think it’s already there. I think they would be completely fine with 3 percent inflation. I think they’d be fine even if moved into the mid-3s.
Remember, the idea is that bond yields remain lower than inflation. So that would be a way of not having so many problems with the compounding of the interest. I mean, if the interest rate’s above the inflation rate, above the economic growth rate, obviously you’re just heading into a fatal compounding curve.
If we buy the idea that the Fed is on this hunt for higher inflation, do you think some large transfers — say, student loan debt forgiveness, or even Universal Basic Income as a more extreme example — are where we’re naturally headed right now politically? It would seem both to scratch that monetary itch and a populist political one to actually do something about wealth inequality.
Yeah, I think UBI has a real shot in the next recession to be something of some significance. The reason I’m saying this with some confidence is we actually already did it in the last recession. We did UBI in the last recession.
Please explain that.
Well the vast majority of households in the United States got a check from the U.S. Treasury, for between, I think it was $300 and $500 — and they did it twice. It wasn’t a lot of money, but the government gave people money. They had negative taxation, basically. You had to be below a certain threshold of income to get the check, but it was a pretty low threshold and a lot of people got it. So there’s there’s precedent of quantitative easing, in response to monetary weakness. There’s precedent for UBI in the context of recession. So maybe next time, it’s just more seriously considered and implemented at a much higher level. I could see that.
So let’s fast-forward to the next recession, something like this plays out and the debt gets a lot bigger. Last month, Ray Dalio put out a big paper suggesting that, given our current situation, all roads lead to two choices: either devaluing our currency to make the debt more manageable or defaulting. He’s suggesting that we’re entering a whole new financial era. Do you think he’s right?
Yeah, I think the dollar would come down under that scenario and I think Ray Dalio’s paper that you referenced is highly logical. I mean, it’s really a fairly difficult conclusion to argue with — that we have $126 trillion of unfunded liabilities against a $19.5 trillion GDP, it’s pretty clear that those liabilities have to be defaulted upon or debased.
In a world with too much debt and too much fiat currency chasing too few assets, Dalio thinks gold is the thing to own in the period ahead — sounds like you agree with him?
I turned positive on gold in a public sense on a webcast in September of last year. At that time gold was at $1,190 [ed: it’s now at $1,500] and I’ve basically been bullish on gold ever since. I own gold miners and, you know, gold miners are doing much better than the S&P 500. So, gold is definitely outperforming financial assets — maybe not the 100-year Austrian bond, which I think was up 100 percent or something … [laughs]
The thing about gold is, the price movement of gold has been very highly correlated, not surprisingly, to the outstanding volume of negative yielding bonds. When you have $16 trillion of negative yielding bonds, that’s $16 trillion where people might say, I think I’ll go for the higher-yielding thing that yields zero — that thing being gold. So as long as we continue to have this interest rate move, gold is going higher.
Does your enthusiasm carry over to Bitcoin, which boosters argue is also a dollar hedge — a “digital gold”?
Bitcoin to me is hugely speculative. I mean, I was bullish on Bitcoin in January — I said the surest way of making 25 percent in 2019 is buying Bitcoin. At the time it was at $4,000, and I said, just buy at $4,000 and sell at $5,000, and make 25 percent. Fifty-seven days after I said that, it was at $5,000. Then it went up to $13,700, but now I think it’s down below $10,000. So it’s all over the place, you know. Bitcoin has shown drops of over 20 percent in five minutes. So to talk about that in terms of a storehouse of value is just absurd. Something that changes that much in five minutes is not useful as a currency.
But blockchain for sure has all kinds of things going for it. I’m going to say the government would love to be in charge of the digital currency, and monitor every single transaction. That would create a tremendous source of tax revenue. You could put a transaction tax on everything with no way to hide from it.
That sounds a lot like Facebook Libra.
All in all, it seems like there might be a lot of messiness in the year ahead.
Well, there probably is. But just look at our politics right now — I think they’re pretty messy.