New Bond King: The interest rate should have been cut in July. The U.S. economy is not as strong as it seems, and interest rates will be cut by 150 basis points in the next year

On Wednesday, July 31, the Federal Reserve concluded its two-day monetary policy meeting and announced to maintain the interest rate at 5.25%-5.50%. Powell stated that a rate cut in September is "possibly under consideration."

On the same afternoon, Jeffrey Gundlach, the CEO and founder of Doubleline known as the "new bond king," appeared on CNBC's Scott Wapner's interview program to discuss the Fed's interest rate decision and Powell's comments.

During the interview, Gundlach pointed out that the Fed should have started a rate cut cycle that day. He believes that the Fed's rate cuts in the future will exceed market expectations, with a total cut of 150 basis points over the next year.

He also discussed expectations of an economic recession, stating that the U.S. economy is not strong, and the actual condition of the labor market is very poor.

Key points of the conversation include:

1. Short-term interest rates on the U.S. Treasury yield curve will fall to the five-year yield, reversing the curve. This prospect has led DoubleLine to gradually reduce floating-rate fixed income assets and instead support fixed rates.

2. Due to seasonal effects, the inflation trend continues to decline.

3. The Fed will cut rates as predicted by the market. If it has to be underestimated/overestimated, the Fed's rate cuts will exceed market expectations, with a total cut of 150 basis points over the next year.

4. Looking back on today in a few years, it will be history, and it is believed that we will be in a recession in September 2024.

5. Employment is a lagging indicator, and the employment trend has worsened, but it has been masked.

6. Gold seems to be in a separate world, which is largely related to geopolitical issues, and geopolitical issues seem to be deteriorating.

7. U.S. debt "interest payments as a percentage of tax revenue are at a completely unsustainable level. In the current structure, we will face a situation where a large part of tax revenue will be used for interest payments. And this situation has reached a point where it can no longer be ignored."

The full interview is as follows, with some content omitted:

Overall Inflation Still Trending Downwards, Fed Has Room for Rate Cuts

Scott Wapner:

What is your reaction to what you just heard?

Jeffrey Gundlach:

I usually summarize the key points of the press conference with one word in these post-red news conference appearances, and the key word of this press conference is "possibly." He said several times, "We may cut rates in September." So he reiterated many times, "If the economy starts to weaken, they have a lot of ammunition, a lot of ammunition."

But interestingly, I think the message Powell conveyed is that he said the labor market and overall economic conditions are similar to pre-pandemic levels, at the threshold of the pandemic, but the federal funds rate is 525 basis points higher than before the pandemic. Well, I admit that the inflation rate may be about 1% higher than before the pandemic, but this means they have a lot of room to lower short-term rates. Our inflation model shows that based on commodity prices and our expectations for housing costs, we can see that the CPI will soon reach the target level of 2%. Meanwhile, the PCE has already reached this level and can even be controlled below 2%. If your real interest rate is positive, even at 1.5%, it means you have a 150 basis points of room for rate cuts, without even considering it as excessive easing.

So I really think we should expect to see the market enjoy what the Fed is saying here, because they are saying that not only can we cut rates at the next meeting, but if needed, we can cut rates significantly. I find this very exciting, especially for those hard-hit stocks, you know, high beta stocks, rate cuts could be very helpful.

Scott Wapner:

In fact, he repeatedly mentioned that as you said, the Fed is still taking a restrictive policy. Should they cut rates today?

Jeffrey Gundlach:

Frankly, I think they should cut rates today. But, whether it's six weeks, eight weeks, or seven weeks, what's the difference. I find it interesting that when people ask about the political climate, they say they don't want to get involved in politics, less than two months away from the election on September 18, this is ridiculous, if you cut rates by 25 basis points, it won't have any impact on the presidential election.

I think if you ask the average American what the federal funds rate is, they don't even know it's a number, let alone what it means, let alone knowing it's now 5.38%.

So I really don't think it's relevant. But I do think it's a press conference that reassures the market. I think Powell is well prepared, he even seems over-prepared. I think he's more "reading the script", especially when answering questions, he seems to be following a script, but that's okay.

Because it's obvious that the employment data is getting worse. I mean, the quit rate is going down. The unemployment rate is now 0.7 percentage points higher than the low point. Government hiring artificially suppressed the unemployment rate, which has been on an interesting upward trend for about the past 18 months, I think it's obviously weakening.

We see continuous increases in initial jobless claims, and first-time claims for unemployment benefits are on the rise. So I think he wants to assure people that he is paying attention to these things. He hopes the unemployment rate won't rise by 0.2% or 0.3% in the coming months. But the unemployment rate has been rising.

Therefore, before the next Fed meeting, we have two more employment reports and two more CPI reports, so I think these will have a strong impact on the comments we receive and whether we will cut rates by 25 basis points.

He seems very clear that based on the current economic and inflation situation, they are not really conservatives. Cutting rates by 50 basis points in September would mean you have to see the unemployment rate rise to 4.3%, 4.4%, or even 4.5% in the next two months, which seems unlikely, but rate cuts are coming. The yield curve is undergoing a shift, we are hovering around 15 to 20, depending on when you look at it The yield of the 2-year Treasury bond is nearly 110 basis points higher than that of the 10-year Treasury bond, which is a significant narrowing but still inverted.

We still believe that the 2-year, 3-year, and 5-year Treasury bonds are very safe havens. When the Fed cuts interest rates once, these bonds should experience a significant rebound.

I think we will start to see the curve turn towards a steeper yield curve. I still feel that the long end of the curve is under anxiety from these interest rates, debt levels, and deficit levels. I know I've been talking about this all along, but it's extremely important in today's world. I believe that support will drop significantly in the next economic recession.

Scott Wapner:

You sound quite optimistic about the current situation of the Fed, perhaps more so than they were 18 months ago, almost two years ago when all this started.

Jeffrey Gundlach:

I am optimistic because I think things have developed quite well. I think Powell has realized this, and I will really come back to talk about this. He said that with the federal funds rate falling, he has a lot of room to do a lot of things, which indeed makes me more optimistic.

I think the inverted yield curve is a problem. I think these high rates, high short-term rates, and high credit card rates are a problem. We see the bottom of the economy, the bottom 40% of the population, really being hurt by these price levels. One way we can monitor this is through food usage. But food, free food, food lines, or whatever you want to call it, have indeed risen significantly in the past 18 months, tripling in some areas.

So, I encourage everyone who is able to donate to these types of public services. The government cannot do everything. I think if done at the private level, the efficiency will be much higher. So, donate to these public services.

Scott Wapner:

Clearly, Jeffrey Gundlach is still with us. Jeffrey, I hope you can help us here. Steve has a question that I think is very good to ask you, because you mentioned that the yield curve is still inverted.

Steve:

Jeffrey, I believe you are also thinking about this, about the steady decline in short-term interest rates, how will the curve change, or how will the curve reverse during this process?

Jeffrey Gundlach:

I think short-term rates will fall, the 2-year Treasury bond rate will fall, the 3-year Treasury bond rate will fall, the 5-year Treasury bond rate will fall, the further out the curve goes, the smaller the decline.

I think Steve's question to Powell is very good. It actually got me thinking about how much room he has to cut, because Steve asked if cutting rates once is a normalization process. I don't know if Powell remembered this question when answering Steve, but if I try to interpret it, it seems to me that Powell's response is normalization. I think he knows that the inflation path may go lower in the short term. One thing he did talk about is seasonal inflation, which I think is more important than most people realize In the first quarter, despite the seasonal adjustments to these data, Powell pointed out that there has been a strange pattern over the years, with a hot performance in the first quarter and a lackluster performance in the second half of the year.

Therefore, overall inflation still has a downward trend, and there seems to be an incredible seasonal factor, which further supports the view that inflation in the fourth quarter is lower than in the first quarter, and of course, lower in the second half of the year than in the first half. Therefore, these factors further support the idea of a rate cut.

Powell is right, we don't know what the data will look like, just like I like his answer, he said, I don't know if he will win the election, trying to compare the policies of one party with those of another party is absurd, you don't even know if it will win. But I do think these things, seasonal inflation is important and will further support the Fed's rate cut.

I expect the Fed to cut rates as predicted by the market, and if I have to make a judgment, I think the Fed's rate cut will exceed market expectations, in the next few months, I think we will see a 150 basis point rate cut, but certainly not until a year later.

Interestingly, the Fed has not adjusted the federal funds rate in the past year, you know, since the last Fed meeting, rates have hardly changed. Therefore, the market seems to have stabilized and is waiting for the start of the rate cut cycle, I think they will be rewarded for this.

Actual deterioration in the job market, the economy is not strong

Scott Wapner:

So, Jeffrey, every time we talk and have these conversations, you also clearly call for an economic recession. As you mentioned before, the Fed chairman today said he thinks we are in a good position. He likes where we are now, he says he thinks the likelihood of a hard landing is low. Have your views changed?

Jeffrey Gundlach:

No, I think the same. I think when we look back, today will become history. When we look back in a few years, I believe we will say we entered a recession in September 2024.

Scott Wapner:

Interestingly, I mean, he still thinks the economy is obviously doing quite well. The Fed chairman said yes, there are some weaknesses, but overall it's still good. Do you also disagree with what you hear from CEOs about consumers?

Jeffrey Gundlach:

I think this has to do with a lot of anecdotal evidence, if you don't look at a stable data point, like the stable data point of the institutional unemployment rate survey, you will find that many things are not so encouraging. When I talk about the unemployment rate being high and low. Even in the hotel industry, the unemployment rate is rising, and so are unemployment claims. Temporary, full-time jobs are being supplemented by part-time jobs. Some people are working a full-time job and a part-time job at the same time. They are counted as two jobs, but it's just one person trying to keep up, keep working hard, keep their head above water, and not let inflation affect them. So I think, I don't know, I just feel like I hear a lot of people saying, "I'm unemployed, can't find a new job" These are just anecdotes, but I lost my job. I have been working in this industry for 10 years, and my company had to close down. I am unemployed, applying for jobs every week, sometimes two jobs a week, but no one is hiring me, I can't find a job. This situation is starting to happen. Yes, employment is a lagging indicator, everyone knows that. But the employment trend has gotten worse.

So, it's being masked. I'll say it again, government hiring is a bit strange. If you want to make the data look better, you can manipulate it by doing some extra hiring in your economic sector, it seems like that's what's happening. Government employment is declining, trending towards stability, and now it's on the rise. So I don't think the economy is that strong.

Scott Wapner:

That's why you have those questions, are you suggesting that when the Fed actually cuts rates, it's too late, because there's rumored evidence and some other data you've seen.

Jeffrey Gundlach:

Yes, that's what I think, because I've been in this industry for over 40 years, it seems to happen every time, because employment is the reason they are hesitant to cut rates, real interest rates are really high. PCE has dropped to 2.5%, 2.6%, the federal funds rate is almost 300 basis points higher than this. So it's very strict. The unemployment rate is rising, all other potential aspects of employment data are not improving, they are deteriorating.

So once it starts to reach the level where they have to start cutting rates, the rate cut will be larger than they imagine. Yes, I think we will see a rate cut of about 150 basis points next year. That's my most fundamental forecast for next year.

Bullish on short-term treasuries, fixed-rate bonds, and gold

Scott Wapner:

I guess that's obviously why you still believe short-term treasuries still have good value here, because you can speculate that rates will continue to decline in the months ahead. So you haven't missed the best opportunity yet.

Jeffrey Gundlach:

Yes, I mean, if rates are lower, when CPI data is released, it changes inflation expectations. People were surprised by the soft CPI data, suddenly, inflation expectations for the next 6 to 9 months dropped by about 50 basis points. But in the portfolio, there is one thing that may be worth considering, that is the Fed will start cutting rates.

I like a metaphor, I think it was Taylor who said: "It looks like they've taken the tea out, now they're putting the ball on the tea, they're going to smash it." At first, they didn't even hold the tea. Then they buried the tea in the ground. Now they put the ball on the tea, they will start cutting rates.

This means that in the past few years, the best trading strategy has been to invest in floating-rate assets, such as high-quality floating-rate bank loans, which is a product I recommend at every meeting. You might want to start, although there is no rush to act tomorrow, gradually shifting to fixed-rate securities. If you hold outstanding double B-rated bank loan products, maybe it's time to consider switching to double B-rated fixed-rate high-yield bonds, I think these bonds are very safe The yield spread in the high-yield bond market is currently very narrow, and the economy is slowing down. However, compared to historical standards, the quality of the double B-rated high-yield bond market is quite good.

Therefore, I am not afraid to hold double B-rated high-yield bonds, and an interest rate of around 8% is not easy to come by, but can be found in a low-risk manner. In fact, we have already started making adjustments in the funds, where we make these types of investments, and we have started making this type of adjustment recently, in fact, this week.

Scott Wapner:

I know our audience appreciates the practical advice you provide. Speaking of gold, you liked gold rising $40 at the intraday high, when we were listening to the comments of the Fed Chairman, of course also analyzing the statement. Do you still like gold?

Jeffrey Gundlach:

Yes. Gold seems to have its own world, I think this has a lot to do with global geopolitical issues, and global geopolitical issues seem to be deteriorating. Think about what has happened in the past 3 to 4 weeks, it's almost hard to believe it's the same month, because we had an assassination incident. Explosions occurred between Israel, Iran, and their northern neighbors. So don't forget about Ukraine, it hasn't disappeared yet.

Of course, we are in the midst of a presidential election circus, you know, candidates are constantly changing, it's a very dangerous geopolitical period. If you want to take an action that you hope the U.S. won't retaliate against, now seems like the time to do so.

Escalating Deficit Issue Requires Unconventional Solutions

Scott Wapner:

I know, speaking of politics, you are still concerned about the deficit issue. In fact, you published an article this morning in a new paper about the rising federal debt and deficit spiral, that's what you said all about. So what do you think will happen in the coming months?

Obviously, who will win the election is still unknown. One of the candidates, a former president, wants to get the expiring tax cuts. Last time you told me you didn't think it was a good idea? Obviously, the Democratic Party has already stimulated the economy through its own spending plans. How do you adjust to this now?

Jeffrey Gundlach:

The deficit issue is escalating. The problem is we can't afford interest payments, and the situation will only get worse. The longer the Fed raises rates, the longer the maturity of the bonds, and many bonds are being refinanced at rates 300, 400, 500 basis points higher. In some cases, rates are even higher than before. So, our interest payments as a percentage of tax revenue are at a completely unsustainable level, and this trend makes it very unsustainable.

We are heading towards a situation where, under the current structure, we will have a significant portion of tax revenue used for interest payments, and this situation has reached a point where you can no longer ignore it, with interest payments exceeding the official defense budget. So, it's skyrocketing, and this needs to be addressed So how do you solve it? You can change welfare. I know this won't happen no matter who is elected, we must discuss this issue, but we must at least discuss it during the midterm presidential election, because we can't afford these, a large number of retirees, they expect and accept these benefits, whether they need them or not.

This won't solve the problem because the outstanding debt is too large. But we must come up with some unconventional solutions, that's why investment business and our political system structure are so fascinating in the next four, five, six, seven years, I have to solve these problems within that time frame.

Otherwise, even though there is an economic recession, the interest rates on 30-year US Treasury bonds will start to rise. That's what worries me.

If an economic recession hits, the deficit will rise, and it may rise even more, as we have seen in 2020, 2021, the government's response is definitely to increase spending and print money, which will lead to a high level of panic, naturally, we will replay the peak inflation of 2022. If we know now, modern monetary theory has been completely exposed.

They say "you can print money, it's okay, inflation won't rise." This really doesn't work, we are still talking about high inflation three years later.

Therefore, this reaction will have a devastating impact on the bond market in the long term. So we will see if they will start doing this. You may see a metaphor, just like what happened in the UK, they had some bad fiscal policies, and long-term interest rates rose by 100 basis points in a very short time. It could even be in one day. If we don't get these policies back on track, this is the risk we face. This means the government won't generate this deficit.

But if that's the case, the change in deficit spending reduction will directly impact GDP. So this is a very interesting puzzle. I hope we have the right character, the right personality, the right intelligence to help solve this problem, because it is now coming at us. This is not a problem for our grandchildren, this is our problem.