The price of oil is up 35% in the last six days, and yet when it comes to inflation, the worst is yet to come for Americans and others around the world, according to DoubleLine CEO Jeffrey Gundlach. Speaking in a webcast sponsored yesterday by Magnifi, the prominent bond investor made a compelling case that the price shocks consumers have seen at the grocery stores, at the gas pumps and in their heating bills are likely to get worse before they get better.
“The Fed is in a really difficult position,” Gundlach said. If it wants to get serious about fighting inflation, “we’re going to need the Fed to be aggressive.”
A major problem is the huge chasm between inflation, currently running at 7.5%, and 10-year Treasurys yielding 1.7% or 1.8%. “Interest rates are now more negative than they were under Jimmy Carter” while oil prices are skyrocketing even faster, he noted. Asked where inflation might peak, Gundlach said 9% or 10%.
In Southern California, premium gasoline that sold at $5.25 a gallon at the start of the year recently hit $7.60 a gallon. People complaining about gas prices “ain’t seen nothing yet,” Gundlach said. Near the end of the webcast, he said oil could top out at $200 a barrel.
The story is the same across a spectrum of commodities. Over the last 18 months, the Bloomberg Commodity Index is up over 100%, Gundlach said.
“The trend is your friend,” he said. “We’ve been talking about temporary inflation in many commodities” for 18 months and there haven’t been any real setbacks.
Supply-chain bottlenecks remain as problematic as ever and demand has yet to roll over. Ultimately, consumer demand will deteriorate, as sentiment surveys like the University of Michigan’s are already signaling.
“All of this stimulus takes time to go through the system,” Gundlach said. “I think recessionary risk is going up very substantially.”
Recession indicators, like the narrowing spread between two-year and 10-year Treasurys, are starting to flash. “Once you are at 25 basis points,” it represents a recession watch, and yesterday that spread reached 15 basis points.
Historically, oil shocks have caused the type of demand destruction that triggers recessions. The number “usually referred to” is a 50% hike in oil prices—and the economy has already surpassed that, Gundlach said.
He believes Fed Chair Jay Powell will get serious about inflation despite the Ukrainian situation. Unlike many commentators who say the war between Russia and the Ukraine will prompt the Fed to adopt a more dovish stance, Gundlach thinks the inflation picture may force it to be more aggressive. If the central bank fails to address inflation, “the Fed doesn’t have any purpose.”
The Fed’s two primary goals are price stability and full employment, at least in recent decades. Employment looks reasonably healthy, so that’s “not going to stop them.”
Another “stealth” goal never mentioned by Fed officials but always on investors’ minds has been the stock market. Whenever equity prices have fallen 20% or 30% since the 1990s, it turns out to be a “reaction point” and Fed policy pivots to support markets.
Gundlach’s biggest fear is that when signs of a slowdown surface, the Fed will resort to its old money-printing ways. “Every time, we do more of it,” he said.
Even if the Fed raises rates four times by late summer, the next recession is likely to start at fairly low interest rate levels. That will lead to “another bailout, which is the only tool they know.”
America’s inflation problems are truly global in nature. Europe and emerging markets are major victims.
Inflation surprises all over the world are at “levels never seen before,” Gundlach said. The U.S. dollar is up 10% in the last year, compounding cost pressures for emerging markets that pay for oil and other commodities in dollars.
When it comes to Russia’s invasion of the Ukraine, Gundlach gave the Biden administration low marks. “Announcing in December that there would be no U.S. troops going into Ukraine is the reason Russia invaded,” he said. “I worry Taiwan [is] in the balance.”
The good news is that the Russian military is performing so poorly that it may cause China to “think twice” about “how easy it is to do these things.” Ultimately, he added, Russia is likely to take over Ukraine because the U.S. will opt not to impose a no-fly zone, “which we are loath to do for very good reasons.”
Over the near term, Gundlach thinks the stock market may be approaching a bottom, with the Nasdaq in bear market territory. He advised U.S. investors to dollar-cost average into emerging market equities.
On the political front, he suspects the midterm elections will be one of “the biggest disasters for the current administration” in his lifetime, thanks in large measure to inflation. A shift away from the 50-50 deadlock in Congress could be a positive development, he added.
Looking forward three years, Gundlach, who famously predicted Donald Trump’s election in 2016, said the next president is unlikely to be either Biden or Trump. With both major parties splintering, a third party is a distinct possibility and the upshot could be that the election is not decided by the Electoral College but in the House of Representatives.