Fed Tightens, “and so far, Nothing Has Blown Up”


by Wolf Richter, Wolf Street:

Gundlach frets about bonds during QE unwind, rate hikes, tax cuts, and rising deficits.

“A tax cut will reduce revenue and it will grow the deficit and therefore, it will probably grow bond supply, and perhaps boost economic growth,” DoubleLine Capital CEO Jeffrey Gundlach said on an investor webcast on Tuesday. And if it does, “it is going to be bond unfriendly.”

And possibly in a big way.

It’s a “strange environment” for cutting corporate taxes as the economy is already in its eighth year of expansion, he said, according to Reuters, which reported the webcast. He reiterated his prediction that the 10-year Treasury yield could reach 6% over the next “four years or so.”

Let that sink in for a moment. The last time the 10-year Treasury yield was at 6% (on the way down) was in August 2000! Four years from now, 6% would be a two-decade high-water mark.

“I don’t think it is at all strange to think we can tack on something like 75 basis points, on average, with volatility of course, per year for the next four years or so,” he said.

The 10-year yield is currently 2.36%, and sliding, as opposed to the shorter maturities whose yields have surged: the three-month yield reached 1.30% today and the two-year yield jumped to 1.83%, the highest since September 2008.

When bond yields rise, bond prices fall by definition. The 10-year yield is still very low. But if it rises from this level to 6% over the next few years, there will be a lot of wailing and gnashing of teeth along the way by bond investors, and it’s not going to be a fun time for a bond-fund manager to navigate this environment.

When Gundlach talks, he is talking his book, and his book is full of bonds, including US Treasuries (DoubleLine manages over $115 billion in assets, as of September 30). So it would seem he’d try to talk down yields, which he has famously done before, which would create capital gains and paper profits for his fund, which would make him look like the “Bond King” that Wall Street has called him. But not this time. This time he is worried about the opposite.

“Growth has accelerated already, and the deficit is already going up, so why cut taxes?” he told Reuters in a follow-up interview.

“It is going to be very interesting to see how the markets can hang on to the easy gains that were made in 2017,” he said. “It’s just so far, so good. The Fed has tightened four times, they’ve embarked on quantitative tightening.”

Fed chair Janet Yellen is leaving a “pretty good legacy,” he said: “She got us off of zero and she started us on the wind down – the quantitative tightening – and so far, nothing has blown up.”

When things don’t blow up, that’s always encouraging in these crazy days of ours.

And during these crazy days of ours, everyone gets asked about Bitcoin, since everyone is talking about it, even on sports shows on the radio, and so Reuters asked him, and he said that he wasn’t at all surprised by Bitcoin:

“It’s a sign of the times. Like the dot-coms back in the day,” he said. Gundlach added that he does not own Bitcoin “just like I never bought a dot-com stock back in the day.” Bitcoin powered to a record high of $11,850 on Tuesday.

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