On Sunday, the world’s largest bond manager tried to throw cold water on the idea that a December hike by the Federal Reserve was a done deal. As reported by Reuters:
DoubleLine Capital co-founder Jeffrey Gundlach said on Sunday that the Federal Reserve may hesitate to raise rates given rocky economic and financial conditions, though the Paris attacks alone are unlikely to play a factor in next month’s decision.
The influential money manager, who recently warned that the U.S. Federal Reserve should not tighten monetary policy in December, said the Paris attacks could pressure stock markets around the globe, “which we know Fed officials have been watching, even if they try not to admit it.”
Gundlach said about a rate hike next month that many economists believe will occur: “Certainly No-Go more likely than most people think. These markets are falling apart.” Los Angeles-based DoubleLine oversees $80 billion in assets under management.
Gundlach cited a number of asset classes that are signaling deteriorating conditions: The S&P Leveraged Loan Index, which is at a four-year low, the SPDR Barclays High Yield Bond Exchange-Traded Fund “very near a four-year low” and the CRB Commodity Index at a 13-year low. “You also have the Eurozone doubling down on stimulus. Fed raising rates? Really?”
Gundlach said emerging markets may lead developed markets lower against the backdrop of rising borrowing costs, noting that Latin American currencies have crashed and Middle East currencies are down. “No wonder” the yield premium demanded by the markets from emerging markets has been rising, he said.
Last year, Gundlach correctly predicted that U.S. Treasury yields would fall, not rise as many others had forecast, because inflationary pressures were non-existent and technical factors, including aging demographics, were at play.
Since the spring, Gundlach has said the U.S. economy and risk markets cannot digest a premature Fed hike.
No sooner had Gundlach raised the idea of a “no hike” in December, CNBC took the theme and slapped it up on TV.
I happen to agree with Gundlach about all of his concerns. Leveraged loans, high yield bonds and the CRB are all sucking wind.
Even with the recent rise in equities, these financial asset classes are still sitting at the lows. I have long held the belief that equities cannot continue rising indefinitely with the plumbing of the financial system showing such big cracks.
Even though I am in Gundlach’s camp that the Federal Reserve should wait, nobody’s opinion matters as much as the members of the FOMC.
The recent economic releases have indicated the global economic slowdown has infected the US economy. There have been a series of disappointing data points over the past couple of weeks.
But I don’t believe any of that matters. The Federal Reserve has been wanting to raise rates for quite some time. Too many members of the FOMC still cling to the Phillip’s Curve and the Taylor Rule for setting monetary policy. At the end of the day the FOMC members are a bunch of bureaucrats, and although they can delay some decisions, there reaches a point where their “rules” force them to act. The recent barnburner employment release will be the tipping point.
The “zero was an emergency rate, and the emergency is long past” crowd amongst the Federal Reserve Committee members will force a rate hike at December’s meeting.
I don’t think there is any point in betting on yet another delay from the Fed. If they do so, they run the risk of completely losing any last shred of credibility they might have left. December 16th will be the first rate hike in nine years, and even Gundlach’s Jedi mind tricks will not stop it.
But the important question to ask is how the Federal Reserve will frame the action. I believe they will attempt to soothe this rate hike with the most dovish language possible. They will even open the door to lowering the Fed Funds rate back down if economic conditions warrant. It will be interpreted by the market as a one and done.
Over the past year, the Federal Reserve’s intransigent desire to raise rates has cast a long shadow over the market. The fact that it is continually threatened, but not yet executed, has created way more uncertainty than is necessary.
Therefore even though I think the Federal Reserve will raise rates in December, I think the correct bet is to assume they will do so in such a dovish manner, it will almost be better than leaving rates unchanged. The removal of the uncertainty, with a commitment to stay pat for a period of time, will be interpreted bullishly.
Maybe I am wrong. Maybe the Fed will hike and set the stage for more hikes. That is always a possibility. But given the poor economic data, with the increasingly dangerous action in the credit markets, I think the correct bet is to assume the Federal Reserve will raise rates in the most dovish way they know how…
Thanks for reading,