Housing prices typically move in the opposite direction of interest rates but, like so many other norms in this bizarre business cycle, this relationship has been thrown into disarray, and DoubleLine CEO Jeffrey Gundlach thinks falling interest rates could actually cause housing prices to fall over the next year.

That’s because a decline in rates could “unlock” the supply of houses for sale in a market paralyzed by a seller’s strike, the high-profile bond manager said yesterday in a webcast.

After the pandemic began in 2020, housing prices climbed dramatically for about two years, since many Americans could lock in mortgages at ultra-low interest rates. But in the last 18 months, activity in housing has slowed to a crawl as much higher mortgage rates have spooked both sellers and buyers.

Housing affordability “hasn’t been this bad in a long, long time,” Gundlach said. Indeed, the pending homes sales index is floundering near 20-year lows. 

Gundlach, who is known for his expertise in mortgage investing and who predicted the 2008 housing crisis, told the audience that pre-payments, historically the biggest risk in the mortgage market, are now a positive for investors, as are low-interest-rate mortgage defaults, which “would help investors get back to 100 [cents on the dollar].” According to some estimates, the value of the average mortgage on banks’ balance sheets is about 83 cents on the dollar. 

This was not the only so-called economic norm that Gundlach sees being challenged in the debt-fueled economic of the 21st century. “Ever since 2000,” federal budget deficits have been “getting bigger and bigger every time we go into a recession,” he said.

At present, the budget deficit is about 6% of GDP while unemployment is at 4%, he continued. During the Great Recession, the budget deficit went to 10%, and during the 2020 pandemic, which he admitted was an unusual circumstance, it went to 20%.

It’s normal for both unemployment and deficits to rise significantly during recessions. But Gundlach notes that in 2015 deficits started rising even though the number of Americans employed continued to rise for the next five years.

If unemployment were to climb relatively modestly to 5% today, Gundlach strongly suspects the deficit would also go up. What makes this current budget deficit different from the one in the previous decade is that interest rates are much higher now—and that’s a problem.

Even assuming there won’t be any recession in the next several years, the Congressional Budget Office anticipates that interest expense on the federal debt will rise from about 15% to more than 20% in the next few years. Gundlach called the CBO’s assumption of no recession “highly unlikely.”

In the last three recessions, the deficit expanded by about 9% of GDP. At some point in the next four or five years, it’s possible that this shortfall could go to $4 trillion or higher, he said.

But this entire “debt-based scheme” will have to change in the next five years. “On the other side, you’ll get the first turning” where things will fall back into place, Gundlach said, referring to a theory of history that holds events follow a pattern of four phases: chaos, awakening, unraveling and crisis.

Getting there will be painful, but it’s bullish for bonds, Gundlach said.

Is a recession coming? Gundlach pointed to numerous indicators that say the economy could be on the front edge of a downturn.

In recent months, the bond market has witnessed a “de-inversion of the yield curve,” which Gundlach says suggests there could be a recession in next year's second quarter.

Moreover, when one examines the U.S. economy at the state level, 32 states are exhibiting negative coincident economic indicators, statistics that change simultaneously with general business conditions like industrial production and unemployment. Gundlach said when that many states are in negative territory, a recession is usually near.

On a positive note, DoubleLine sees the Consumer Price Index coming in at 3% or thereabouts for the next few months and falling to around the 2.5% area by the middle of 2024.

The supply chain bottleneck that plagued the reopening of the economy in 2021 and 2022 is a thing of the past today. Gundlach cited a New York Fed bottleneck index that was as negative as it has ever been.