Economic expansions, like loans with dubious credit quality, can keep rolling over for a long time with continuous market manipulation from central banks and others. Throw in an improvement in consumer confidence, a fall in interest rates and a stock market recovery, and you have several of the reasons why DoubleLine CEO Jeffrey Gundlach has reduced his U.S. recession odds for 2020 from 65% to 35%.
That said, the world remains an increasingly strange place. At one point late this past summer, more than half the bonds outside the U.S. in the Barclay's global aggregate index were sporting negative yields. Trillions of these bonds, or about 33%, still are.
Around that time, Gundlach was visiting Europe, where he was asked if he would buy bonds selling negative interest rates or avoid bonds altogether. He said he would not advise anyone to buy bonds with negative yields.
One piece of good news in this story is that Federal Reserve Board chairman Jay Powell has said he would not fight the next recession with negative interest rates. Gundlach has been a critic of Powell on many issues—particularly his decision to raise rates four times in 2018 and then cut them three times in 2019—but he applauded the Fed chairman for taking negative rates off the table. Instead, the U.S. central bank is more likely to resort to asset purchases and other forms of market manipulation when the economy heads south.
But over the short term, the picture is improving, even though the yield “is de-inverting,” which Gundlach noted often happens before a recession. Consumer confidence is ticking up and the Leading Economic Indicators should look better as it goes up against easy comparisons in 2020’s first quarter.
The Global Yield Drought
Global yield starvation contributed to the dramatic decline in interest rates this year, Gundlach said on a webcast. Foreign investors are willing to take unhedged dollar risk for now. He added that the dollar has remained largely flat in price despite a flood of assets into U.S. Treasurys and other financial instruments. If the greenback were to head south, the same foreign investors who flooded into U.S. markets this year could all try to get out at once, and problems could be exacerbated in a stampede for the exits.
Other disparities between America and foreign financial markets also could create more severe imbalances going forward. For all its problems, the Eurozone is barely running a deficit—Germany is actually running a surplus.
That helps explain why U.S interest rates are much higher, Gundlach said. America simply has a much greater supply of government and corporate bonds to sell and buyers demand more.
For Americans so confident their economy is far superior to Europe’s, this stark fact is sobering. Perhaps U.S. growth is better largely because of its ability to sell massive quantities of debt—and sooner than later the chickens are likely to come home to roost. President Trump “seems to be happy” running the same kind of spending deficits “he railed against as a candidate.” Expectations that the Democrats might be any different in today’s world are questionable.
The Reckoning Is Coming
Gundlach has said for years that the coming decade will be one of reckoning for America as the problems of Social Security, Medicare and trillion-dollar deficits—which the Congressional Budget Office predicts will become the norm after 2022—all converge simultaneously. In yesterday’s webcast, he predicted that the federal budget deficit could hit 13% of GDP in the next recession.