Jeff Gundlach: I Just Hope The Fed Thinks Carefully About What It Is Doing by Christoph Gisiger, Finanz und Wirtschaft

Jeff Gundlach, CEO of the investment firm DoubleLine, is bullish on the Dollar and worried that a rise in interest rates could cause an economic downturn in the United States.

In the worlds’ financial markets things are coming thick and fast. Oil prices are spinning down, the Rubel is collapsing, and the Swiss National Bank is introducing negative interest rates. At the same time, the Federal Reserve is getting ready for the first interest rate hike in over half a decade. Jeff Gundlach worries that this could be a severe mistake. The outspoken and highly influential CEO of the investment boutique DoubleLine was one of just a few contrarians who, at the end of last year, were correctly predicting that long term U.S. interest rates would decrease in 2014. Now, he spots warning lights in the bond market signaling the growing risk of a severe setback for the American economy that even could turn into a recession.

Mr. Gundlach, on Wall Street you are well known as an influential bond investor. But you are also a connoisseur of art and even tried to start a career as a drummer in a rock band. What tune comes to your mind when you look at the financial markets these days?

Jeff Gundlach: I have kind of lost track of music. I do not know any songs that have been written since about 1997. People around here, they all hear Radiohead and that stuff – I do not know a single song. But there is an old record by Led Zeppelin called «The Song Remains the Same» – and that is kind of what is going on: Basically all over the world, we have continued accommodative policies, to put it mildly.

Sounds almost a little bit monotonously.

Jeff Gundlach: What has changed in the financial markets is the strength of the Dollar. When the Dollar started strengthening, a lot of things started to change. The Japanese stock market started to go up again. Also, the Chinese stock market started to go up finally. In the United States, the junk bond market started to weaken. Now, junk bonds are at the low of the year whereas treasury bond prices are close to the high of the year. In the equity market, for two years, weak balance sheet companies were doing better or outperforming. Starting in this year, strong balance sheet companies were beginning to outperform. This is exactly consistent with the weakness in junk bonds.

And what does this mean?

Jeff Gundlach: It is interesting how you have been beginning to see signs of investor concern around the edges about the health of the economy and about the financial system. Historically, when junk bonds give up the ghost and treasuries remain firm, it is a signal that something is not right.

So what is wrong?

Jeff Gundlach: I think that certain things are starting to concern investors and maybe it is all tied around speculation on the Federal Reserve raising interest rates. As prospects for a Fed tightening have increased over the year, the Dollar has strengthened and the treasury bond market has been declining in yields. It is almost as if the treasury market and the junk bond market are projecting that the Fed raising interest rates will cause a recession. I am not going to predict that myself. I am just reading what the market’s message is. How could you explain all these markets acting this way? Well, it seems like as if it had something to do with a policy mistake.

That raises memories of 1937. At that time, the Fed prematurely tightened monetary policy and the economy fell back into a recession. Why would the Fed risk to repeat the blunder of 1937?

Jeff Gundlach: The Fed has never kept rates stable for six years, let alone at zero. I just believe that the Fed may want to raise rates simply for that reason. They must be aware that the longer they keep rates at zero the more distorted investor psychology and behavior becomes. The best friend of risk assets and basically all none income paying assets is zero interest rate policy. That is why Ferraris are up 500% in the past few years and Picassos at the very high end are shattering records. I just think the Fed realizes that if we go on with zero, people’s psychology will be even much more distorted. So they want to raise interest rates largely just to see what happens.

Is the U.S. economy not strong enough for a moderate raise of interest rates? For instance, the unemployment rate is already down at 5.8% and closes in on the 5.2 to 5.5% range which is considered as maximum employment.

Jeff Gundlach: It is really a mistake to compare today’s unemployment rate to what would have been an unemployment rate around 6% roughly twenty years ago. Today, there is a great shift towards part time employment. For example Wal-Mart is very visible in this regard. They intentionally hire people for less than 26 hours a week to avoid Obamacare. Well, that means that what used to be three jobs is now five jobs. There is not more money into the economy. Also, what you have is employment growth for people who are over 55. Why is that? They cannot retire because interest rates are at zero. With interest rates at zero an infinite amount of money earns zero, let alone a finite amount of money like $300’000 or $800’000 or whatever the particular individual has saved. There is no chance that they can live off of that. Therefore, what many older people do is they work. But there is very little movement regarding young people. So it seems like the Fed, for reasons that are philosophical rather than fundamental, may raise interest rates.

What do you mean by that?

Jeff Gundlach: I think they are just nervous about zero interest rate policy going on this long and not having tools to fight any future weakness in the economy. What the Fed wants to do is get off of zero so at least they have the ability to ease down the line. But fundamentally, there is very little reason why they should raise interest rates. The price of oil dropping to $55 a barrel is a very strong sign that there will be perhaps no inflation at all in the United States. The only places where there is inflation is in places that are painful. It is in shelter and in food but not in wages which would help parts of the society. Raising interest rates against that backdrop seems like a poor idea. So I just hope the Fed thinks carefully about what it is doing.

The crash in the oil market is already causing jitters in the financial markets around the globe. What is your take on that?

Jeff Gundlach: Oil is incredibly important right now. If oil falls to around $40 a barrel then I think the yield on ten year treasury note is going to 1%. I hope it does not go to $40 because then something is very, very wrong with the world, not just the economy. The geopolitical consequences could be – to put it bluntly – terrifying.

At present, a barrel of WTI oil trades at around $55. What are the consequences of that?

Jeff Gundlach: Those who want to be optimistic on asset prices say this a tremendous economic benefit because it is a tax cut. Clearly there is some truth to that: You pay less for gasoline and you can buy more junk food. But there are some other, pretty substantial ramifications, not only on inflation. At this level oil is starting to have an impact probably on employment in the United States. The job growth and the economic growth in the fracking regions is monumental and it has to slow down with oil below $60. So you could see employment starting to drop a little bit. At some point with the global economy weakening and the Dollar strengthening, there is a real chance that the U.S. will import economic weakness and deflation. So if the Fed raises the Federal Funds Rate I actually think long rates will not even go up.

How about the risk that the drop in oil prices spills over into the financial markets?

Jeff Gundlach: Something between 14 and 19% of the junk bond market are energy related. So when you have oil prices staying where they are for several months  – which is likely because that is a policy decision that some oil producers have made – some of these companies will start to really run into financial troubles. Now, some people are saying:  «That is confined to energy, it is a pocket of the economy, everything else is OK and insulated.» But that argument usually does not work. When the housing market started to get weak in the subprime category, even Ben Bernanke said: «That does not matter,

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