A recession could be anywhere from one to six months away—at least that’s what’s suggested by economic indicators that have proved correct in the past, said DoubleLine CEO Jeffrey Gundlach, speaking on a webcast yesterday.

Gundlach addressed a number of issues suggesting recession was imminent and what it means for the bond market.

While the bond market expects the Federal Reserve to raise the fed funds rate to 5.0%, Gundlach was skeptical. “After [the Fed meeting] next week, we’ll be done with 75 basis point [rate hikes],” he said. “I don’t think we’ll make it to 5.0%.”

Indeed, signals embedded in bonds already reveal that their prices are starting to come around to Gundlach’s viewpoint. In early November, the bond market was pricing in a peak fed funds rate of 5.17%. Now it’s down marginally to about 5.0%.

“One thing that’s clear is that inflation is coming down,” Gundlach said. DoubleLine estimates that when May’s Consumer Price Index results are announced in June, they will be below 4.5%.

What the bond market maven finds striking is the market expectations for the declining path of inflation in 2023. He produced a chart of inflation expectations that bore out his doubts.

It displayed the anticipation that the inflation rate will “come down exactly as fast as it came up.” Then, somewhat “implausibly,” experts expect it to stay at 2.5%, and “stay there until 2026,” he said.

Markets and economists, it would seem, share an almost magical faith in the Fed. “If, and this is an ‘if,’ the Fed succeeds and inflation goes to 3% next year, I predict it won’t stop there,” Gundlach said. “If it goes to 2%, then it will go far below that.” He added that under this scenario, price increases might even turn negative, and we could enter at least a brief period of deflation.

The forecast of inflation returning to 2% “has been around a while." This time “it might come true, but I’m not convinced,” he told attendees.

However, he is far more confident that inflation will fall to around 4.5% by midyear 2023. “Nothing is happening in commodities,” he said. Twelve to 28 months ago, many of them were soaring as the world emerged from the pandemic.

The U.S. dollar has just started to decline, and Gundlach expects it could be an extended period of reversal for the greenback. Changes in other monetary conditions are also taking place. “M2 growth is basically the lowest of my lifetime,” Gundlach said, adding he was born in 1959. 

The savings rate, after soaring in 2020, has collapsed, implying there’s going to be weaker consumption. He produced a chart revealing that the decline in the savings rate has been accelerating for many months. Credit card debt continues to climb, and Gundlach suggested consumers are being forced to use plastic to pay for food and gas.  

The index of leading economic indicators also suggests a recession and some of the indicators resemble the approach of a significant recession as they did before the financial crisis. An array of sentiment indicators and the yield curve appear similar to what they were “on the front edge” of past recessions, he said.

Many other signals of a downturn are flashing. For example, the Institute for Supply Management’s Purchasing Managers Index suggests there will be a recession in two months, he added.

Remember all those supply chain bottlenecks the news media was obsessed with a year ago? Today, supply delivery delays are near their lowest levels in 40 years, Gundlach said.

Another recession indicator is the combination of two unemployment measures that occurs when the unemployment rate crosses above its 12-month moving average. Gundlach expects that to happen sometime next year when unemployment climbs above 4%.

Then there is the issue of housing affordability. In the pre-pandemic era, the typical mortgage payment for the average new home was 17% of disposable income, Gundlach said. Today, that figure is 33%.

“A lot of people won’t want to move,” he said. While a mortgage is technically a liability, Gundlach says that ironically it’s many Americans’ best asset, given the current level of mortgage rates.

Housing inventories are sitting at a nine-month high, which Gundlach said is also “coincident with a recession.” For the first time in memory, the refinancing index is at zero, he said.

Even if mortgage rates were to fall 200 basis points, or by 2.0%, 92% of mortgages could not be refinanced, he said. That's one thing making mortgage-backed securities attractive now, since prepayments have always been one of the biggest risks for investors in this sector.

Junk bonds could also be good investments if the economy goes into a recession and the bonds’ prices decline. Even if they default, Gundlach said, and prices fall to 50, 60 or 70 cents on the dollar, investors could make money when the issuing companies reorganize.

In the stock market, Gundlach noted that the Dow Jones Industrial Average has performed relatively well this year. He also expects value to continue to outperform growth.

Most significantly, he thinks global markets could be at an inflection point. Since the financial crisis, U.S. equities, as measured by the S&P 500, have outperformed the rest of the world by about 300%. When the U.S. dollar inevitably reverses its trend, which may be underway, Gundlach says that’s going to change. Over the last two years, he called U.S. and European stocks “virtually tied.”

Since 2011, U.S. stocks have trounced the MSCI Emerging Markets Index by 4.5 times. “That could be reversing,” Gundlach said.