“We called it exceptionalism, too, when there was Standard Oil and U.S. Steel and these massive tycoons who created these enterprises, but when a bear market comes, you don’t call it exceptional anymore. You call it monopoly or a trust that needs to be busted,” said Gundlach. “That kind of American exceptionalism is going to be tested.”
Gundlach noted that while considered a great American disaster, the early 1900s earthquake in San Francisco actually caused few injuries and fatalities. It was the fire that resulted from the earthquake that decimated the city. "A lot of times it's not the earthquake, it's the fire," he said. An impending second wave of layoffs and another downturn in financial markets could erode what’s left of the country’s economic stability.
“I believe there’s another fire coming,” he said, adding that rising unemployment often equates to rising levels of unrest. The employment-to-population ratio has reached 52.8%, he said. If it falls below 50%, that’s “an upside-down society where you have less than half of the population employed. That situation could get seriously out of hand from a socioeconomic point of view.”
Fed Watching
If Treasury yields continue to rise on the long end of the curve, the Federal Reserve is likely to attempt some form of yield curve control. Whether they’re effective or not is a different story. Gundlach argues that thus far, the Fed’s low- and zero-interest rate policies have not been fruitful. Nor has its monetary stimulus.
Eleven years after the fiscal crisis prompted what were then unprecedented monetary policies by central bankers, the U.S. is back in a recession with high levels of unemployment and the same zero-rate interest policy and quantitative easing programs it had engaged in before – but “on steroids,” he said.
“What strikes me as being worth pondering are two questions: What is the end-game to these policies, and two, do these policies work,” said Gundlach. “I don’t think they work. If they worked, we wouldn’t be back at them on steroids 10 years after we first used them. Once something gets embedded as policy, it works for a while, and then you have to reapply it. That means it really doesn’t work, and also, the length of time [between the use of such policies] shrinks regressively. ... it took us 10 years to have to go back to a zero-interest-rate policy and bigger quantitative easing. Next time we’ll have hyper-QE and maybe it won’t be zero-interest-rate policy, but negative interest rates.”
Thus far, policymakers have mostly focused on the 3-year to 10-year parts of the curve, but they will take action to keep long-term borrowing costs low for U.S. companies, said Gundlach.
"Obviously yield-curve control is lurking in the background of the conversation," he said. "I certainly do expect that Jay Powell would follow through on controlling the yield curve should the 30-year rate really get unhinged."
The Fed is likely to keep short-term interest rates at or near zero for at least two years, said Gundlach. He also pointed out that areas of the bond market that went without Fed support during the criisis—agency mortgage backed securities, for example—have not experienced a flood of forebearances or defaults as many had feared. Even student loans experienced higher levels of forbearance during the 2008-09 global financial crisis than they have during the pandemic, said Gundlach.
The worst performers in the bond market recently have been corporate and high-yield credits, where after a boost from the Fed buying investment-grade and high-yield bond ETFs, both sectors have fallen. in part because front-running in ETFs like LQD and HYG. Corporate bonds “are not the place to be,” Gundlach said, because Fed action turned a “drip” of outflows into an “ocean," allowing the price for LQD to rise close to its all-time high while the underlying bonds are “not performing. ... Yet money has been piling in. I think this has to be a set-up for disappointment.”