Gundlach Blames “Fed Manipulation” For Repo Market Madness

It wasn’t so long ago that Jeffrey Gundlach, founder of DoubleLine Capital, said he would never again appear on CNBC, after a particularly contentious interview last year that led to some brief drama between him and Jim Cramer.

But on Wednesday afternoon, Gundlach invited “the Judge” – CNBC’s Scott Wapner – to his company’s offices for an hour-long interview where Gundlach explained his relatively recent turn toward bullishness on the US economy and equity market – even though he still has all the long-term gripes about the Fed and monetary policy that he’s shared with business journalists for years.

Gundlach started off by saying that “one of the most important statements that has gotten less play than it should is Jay Powell said in late October that we would have to see a ‘significant’ rise in inflation that is persistent to even consider raising interest rates to fight inflation.”

To Gundlach, it’s evidence that the Fed wants to keep benchmark rates below the rate of inflation to keep negative real rates in effect for the US economy. He also claimed that the Fed “knows we have a debt problem” and probably wants to push the day of reckoning as far into the future as possible.

“So the Fed wants inflation to be higher, actually, and they’ve contextualized this by saying ‘well, 2% was our target for many years and we fell short, so now we need to fill the gap’, which makes no sense to me whatsoever. I think it’s cover for wanting interest rates to basically be below the inflation rate, which seems to be the game plan for central banks in developed countries around the world.”

“So now we have the 10-year Treasury yield is below the inflation rate and CPI is up at 2%, core CPI is up higher than 2%, and yet the interest rates are being kept below that. The Fed knows that we have a debt problem in the United States and that the way to push the day of reckoning out into the future is to keep interest rates below the inflation rate.”

Overall, Gundlach’s comments about Jay Powell were largely negative, though he appears to disagree with President Trump about the need for rate cuts last year.

“Its difficult to give him a lot of credibility...instead of raising rates, we’ve cut rates.”

But Powell has one redeeming quality.

“One reason I’d give him a C- and not a D is he has said that to fight the next recession, negative interest rates won’t happen in the United States.”

Looking ahead, whenever the next recession arrives, the Fed will be ill-equipped to defend the economy from its ill-effects. And markets, as the round-trip we’ve taken over the past year or so shows, are in sync with the central bank.

“Now the market is completely in sync with the Fed. What Jay Powell has done is he raised rates four times in 2018 and cut rates three times in 2019 we’ve been on a wild ride,” Gundlach said.

Convincing the Fed to hike rates at this point would be extremely difficult, Gundlach said. Even if inflation made a comeback, “it will need to be pretty remarkable,” he said.

“The Federal Reserve has turned into a body that’s essentially following the market. And now the bond market is saying there’s no purpose in raising rates, there’s no purpose in cutting rates, we’ll probably be unchanged with interest rates until the third quarter of next year.”

Moving on to a discussion of the labor market, Gundlach offered an insightful explanation for why the economy ‘feels’ better today than it did under Obama.

“People keep talking about how good the labor market is and, yes, it’s good – for sure. But the jobs growth under Trump has actually been lower than Obama…what’s better is people aren’t getting laid off. Weekly unemployment claims are really low…they’re down about 30% from the last three years of Obama. That, I think, is why the economy is perceived to be better on the jobs market because the labor market participation has increased.”

Whatever happens in the coming months, Gundlach is convinced that there won’t be a recession before the end of 2020. He insisted that there haven’t been enough ‘leading indicators’ going off.

“I think there’s unlikely to be a recession…the odds are there won’t be a recession before the end of 2020.”

Still, people are definitely spooked, and one wouldn’t be wrong to call last summer a period of paranoia for the Street.

“In the summer, there were white papers circulating on Wall Street calling on the Fed to make a 50 basis point emergency cut thanks to some of the global manufacturing data out there.”

As for Trump’s ‘Phase One’ trade deal, Gundlach believes it’s mostly a sham, concocted to give off the illusion that progress is being made with China, even though there’s no evidence of that. Going even further, Gundlach said the press conference where Trump and Liu He unveiled he ‘agreement’ was perhaps the low point in Trump’s presidency.

“I don’t think there will be a substantive deal before the election, I’ve thought that all year,” Gundlach said.

Finally, Gundlach offered some thoughts about the political situation. He said his ‘base case’ for the 2020 election is a Trump victory, though he also said the market is under-pricing the risk of Elizabeth Warren, Bernie Sanders and the impact of the resurgent left.

He likes Pete Buttigieg, but fears he’s “way too young” to be president, especially after only ever having run the city of South Bend.

Soon, CNBC asked Gundlach to explain the blowup in repo markets that began in September came about, and the Fed’s role in causing the panic in money markets.

Gundlach said the fact that there weren’t buyers for o/n money is a sign that the Fed is keeping interest rates at artificially manipulated levels.

“What’s interesting about that is the overnight repo market had been struggling to stay in lines with the Fed funds rate but that day Sept. 17 it just blew out and the Fed had to panic and come to the rescue and add reserves to the system…that to me is a worrisome development because it suggests that the market doesn’t ratify the Fed funds rate. The Fed funds rate is at a level that really isn’t clearing the market…that corroborates my viewpoint, which I think is a minority opinion.”

“It’s really telling that you can’t find buyers for overnight money in excess of a 2% interest rate and yet the 10-year Treasury is below 2% with inflation at 2% and higher. It tells you that the inflation levels being maintained by the Fed aren’t market levels…they’re manipulated levels.”

Watch the full interview below: