Jeffrey Gundlach has had a good run this year handicapping the $14.9 trillion Treasury market.
DoubleLine Capital’s chief investment officer said in January that the benchmark 10-year U.S. yield would keep rising if it broke past the 2017 high of 2.63 per cent. It did. In April, just as the yield reached 3 percent for the first time since 2014, Gundlach said he had “low conviction” that it would sustain that level. Sure enough, it has closed below that threshold for 15 consecutive sessions.
And he’s repeatedly said the 30-year U.S. yield would need to breach 3.22 per cent - and not just once, but twice - for long bonds to enter a bear market. Almost to the decimal point, that call has panned out, with the yield settling in below that key mark.
So it’s eye-catching, then, that Gundlach reiterated in a webcast on Tuesday his call that the 10-year Treasury yield would rise to 6 per cent by 2020 or 2021. “We’re right on track” for that, he said. As a reminder, that would be the highest yield since 2000.
His reasoning is fairly straightforward. The combination of rising U.S. interest rates and fiscal deficits is like a “suicide mission,” he said in the webcast, escalating the intensity from last month, when he referred to the trend as a “pretty dangerous cocktail.” Ultimately, the debt burden will rise to such a level that borrowing costs will surge, in his estimation. That hasn’t happened yet because ultra-low German yields are capping how much Treasuries can sell off.
But Gundlach also said a recession is possible by 2020, which could make the next presidential election “a wild ride.” Usually, interest rates tend to fall during economic slowdowns as the Federal Reserve shifts to accommodative monetary policy.
In one of his recent webcasts, Gundlach referenced Lacy Hunt, the well-known bond bull at Hoisington Investment Management. As he has said in many of his quarterly publications, yields are destined to fall, rather than rise, because of the global sovereign-debt overhang. The Fed will have to stop raising rates and start cutting them and probably resume its quantitative easing program for good measure.
“I believe that we’re closer to the peak - or at the peak - at the longer end of the market,” Hunt said in a phone interview. “You come in and undertake a massive increase in debt, and the economy gets a transitory boost in economic activity. The consumer has already spent a lot of the tax cut, but the debt lingers.”
Rock-bottom interest rates, essentially, are the only way the U.S. can afford to pay what it owes. Just look at Japan, where the debt-to-GDP ratio has exceeded 200 per cent for years and its 10-year yield is controlled to stay near zero.
Now, most strategists and economists don’t see that sort of scenario playing out anytime soon. In fact, the consensus agrees with Gundlach that Treasury yields are headed higher. But the median forecast among 28 analysts surveyed by Bloomberg this month is for the U.S. 10-year yield to rise to just 3.5 per cent by this time in 2020 from 2.95 percent now.
Even the most ambitious forecasts don’t go as far as Gundlach. John Dunham at Guerrilla Economics in Brooklyn expects the 10-year yield to reach 4.63 per cent in two years. Tom Fullerton, a professor at the University of Texas at El Paso, forecasts 4.6 per cent.
Gundlach made some important points about the societal cost of running up budget deficits to largely finance tax cuts. Namely, that it’s putting the U.S. way behind in taking care of its aging infrastructure. And perhaps his Treasuries call came from a similar place - concern about the country’s fiscal position. Borrowing costs soaring to that extent would surely catch the attention of Tea Party Republicans in Congress, who pushed the U.S. to the brink during the 2011 debt-ceiling crisis.
Based on the current market dynamics, however, Gundlach is unlikely to find much company for his 6 percent call. Global central banks are stepping back from stimulus at a glacial pace, and that’s reflected in the still-low level of sovereign-debt yields. Something, somewhere would have to snap.
Then we’d all be in for a wild ride, indeed.