Trump will win, interest rates will rise and a new era of fiscal stimulus will begin, leading to doom and gloom for the bond markets, said DoubleLine Capital CEO Jeffrey Gundlach.
Deficits and debt are about to mushroom no matter who becomes president, said Gundlach, who addressed attendees at the Schwab IMPACT 2016 conference in San Diego on Tuesday.
As entitlement programs bear the costs of baby boomer retirements, economic policy moves from monetary manipulation to fiscal stimulus and the tabs for three rounds of quantitative easing become due, Gundlach said the deficit could reach $1.5 trillion within five years.
“We’re in the eye of the hurricane for the next three to four years,” Gundlach said. “Come 2018, 2019 and 2020, look out.”
Advisors and investors have become complacent about the lower-for-longer global monetary policy regime, said Gundlach — which may be a sign that extraordinary moves like negative interest rates and quantitative easing are on their way out.
“A narrative that has been dominating the markets for the past six years is not at the beginning, it’s at the end,” Gundlach says. “The monetary regime is at the bottom of the ninth inning.”
The era of exceptional monetary policy is over, but that doesn’t mean that rates will rise significantly in the near term.
Gundlach took a moment to skewer the Federal Reserve Board of Governors for one of their attempts at transparency — the “dot plot” interest rate forecasts which never prove to be true.
“The dots have completely destroyed the Fed’s credibility; they have cried wolf too many times,” Gundlach said.
Gundlach also took Fed Chairman Janet Yellen to task for quietly changing the Board’s unemployment and inflation targets, citing comments by Yellen calling for a “high-pressure economy.”
A high-pressure economy would mean an inflation rate above the Fed’s previous 2 percent threshold and an unemployment rate below the Fed’s 5 percent target, according to Gundlach.
“You can find the phrase ‘high-pressure economy’ in a paper from the Brookings Institute,” Gundlach said. “High-pressure economies function at a 4 percent or lower unemployment rate – thus Yellen has moved the goal post from a 5 percent threshold for tightening to a 4 percent threshold.”
As the era of activist central banks seems poised to end, Gundlach told his audience that a new era of fiscal stimulus is beginning.
Gundlach said that fiscal stimulus already takes place in the United States in the form of entitlement programs, but that policymakers will likely look for more ways to encourage economic activity through spending.
“In the Nordic areas, they’ve been talking about helicopter money, and in Japan they’ve floated the idea of giving out 1,000 yen per year per person,” Gundlach said. “That’s $94, so not a lot of money, but it’s the thought that counts. Once you’ve gotten started, you’re in the fiscal stimulus business.”
In the meantime, slowly rising interest rates and a possible up-tick in inflation spells bad news for the U.S. bond market, said Gundlach, and support from foreign investors is likely to dissipate because of the relative strength of the dollar against the volatility of other currencies.
“These foreign investors are also bearing currency risk,” Gundlach said. “You can’t just look at the spread, you have to look at the spread hedge. Now, if you hedge the currency, you earn nothing.”
Gundlach said that foreign investors have already moved to sell Treasuries, citing statistics showing a drop in ownership by sovereign wealth funds.
The bond market will also suffer due to the rising rate environment, said Gundlach.
Bond yields bottomed in July when 10-Year U.S. Treasury bonds yielded 1.32 percent. Yields are not likely to return to those lowest levels in the foreseeable future, according to Gundlach.
“More than three-fourths of the bonds in the world right now are negative yielders,” Gundlach says. “I think that number continues to go down; negative bonds have already started to decline. Why is this monetary experiment at an end? It has to do with the banks. … It’s a bad idea to keep a policy in place that’s going to implode your banking system.”
Gundlach predicted that the inflation would rise over 3 percent by April 2017, which could prompt the Fed to continue raising rates.
With inflation rearing its ugly head, Gundlach targeted TIPS as a potential area of opportunity for fixed-income investors.
“TIPS are for winners,” Gundlach announced. “You can already see that TIPS are outperforming because the inflation expectation is increasing.”
Gundlach doubled down on his forecast that Donald Trump would defeat Hillary Clinton in the upcoming election, commenting as the iconic image of Mohammad Ali — then Cassius Clay — standing over a defeated Sonny Liston.
“Liston was a massive favorite going into that fight,” Gundlach said. “Just like the Britain ‘stay’ vote was a massive favorite, and just like Trump is supposedly behind.”
Since both major party candidates are proposing massive increases in infrastructure spending, Gundlach believes that either choice will lead to increasing deficits and an expansion of the national debt.
Debt and other crises means the next presidential administration will be short-lived, said Gundlach, predicting that no matter who wins, the next president will serve only one term.
