A decisive majority of Federal Reserve governors are sticking to their hawkish hard line on interest rates, but the financial markets are buying intoanother story.

Wall Street’s optimistic interpretation of recent economic data is based on a view that inflation has peaked and the U.S. could be one or two months away from a recession. This clash in perspectives makes the bond market "absolutely exciting" in the view of one of its biggest players.

DoubleLine CEO Jeffrey Gundlach told clients yesterday he was betting on the markets, citing evidence that, in past recessions, the Fed was wrong and the markets were repeatedly right. “Look at what the market says and take it more seriously than what the Fed says,” he urged them, chiding the media for the reverence that continually treated endless pronouncements from central bankers.

The two-year Treasury rate historically has proved to be a far better signal of where markets are headed than the fed funds rate. The markets, Gundlach noted, are implying that the two-year rate will peak at 4.93% according to Bloomberg data, not the 5%-plus level cited by some Fed governors. It’s a small difference, but one that could be significant, prompting the central bank to cut rates sooner than its spokespeople are currently intimating. “The markets control the two-year Treasury, not the Fed,” he added.

In a webcast entitled “What’s Going On?” after the Marvin Gaye hit, Gundlach contrasted today’s financial markets with those of a year ago. Even though most measures of equity valuations placed them in the top one or two percentiles on a historical basis, stocks in January 2022 were cheap compared with bonds.

But 2022 would turn out to be the worst year for bonds “by several hundred basis points.” Gundlach now believes there are buying opportunities in many fixed-income sectors, though he remains cautious about U.S. equities in particular.

Economic conditions are changing fast. Gundlach pointed to all the news about supply chain bottlenecks that dominated the headlines in the months after the economy reopened in 2021. Today, delivery problems have largely “disappeared.”

Most people are “treating it as good news,” but Gundlach noted that it may signal that consumer demand is falling in the face of higher prices. Demand for housing has “collapsed” as a result of soaring mortgage rates, and Americans are dipping into excess savings built up during the pandemic.

Signs of consumers stress are numerous. Consumer sentiment remains very low and job opening rates, as revealed in the Bureau of Labor Statistics’ Job Openings And Labor Turnover Survey, recently showed a modest decline.

The index of leading economic indicators has “the look of an [imminent] recession,” Gundlach said. So do various measures from the Institute of Supply Management and its Purchasing Managers’ Index.

Gundlach touted DoubleLine’s internal methodology to measure inflation as quite accurate, saying it predicted inflation would reach 8%, which was much closer to the actual peak of 9% that blindsided many economists and Wall Street firms. He also observed that inflation was falling at almost the same rate as it rose and said the market is expecting to reach about 3.0% by year’s end. That’s lower than the 3.5% forecast of economists surveyed by Bloomberg.

Regarding the implications for equities, Gundlach observed that “real yields have stopped going up.” That is “good news for risk assets.”

The S&P 500 is actually up 4% from its low near the Fed meeting last June. But that low has been followed by bear market rallies that, as of yet, have failed to prove sustainable.

In his view, the best move for equity investors is to tilt their portfolios as far away from mega-cap U.S. stocks as possible. That means favoring the S&P 500 over the Nasdaq-100, favoring an equal-weighted S&P 500 over the market-cap weighted version and weighting European and emerging market equities over their domestic counterparts.