Gundlach: A Debt Ceiling Impasse Could Drive Rates Lower

Jeffrey Gundlach

Failing to raise the debt ceiling would be a “huge financial calamity,” according to Federal Reserve Chairman Ben Bernanke and the general consensus view.  But that opinion is “exactly wrong,” at least as far as the Treasury market is concerned, DoubleLine’s Jeffrey Gundlach said in a conference call with investors last Tuesday. 

Rates might actually go down, just as they did after the end of QE2, according to Gundlach.

Gundlach is the founder and chief investment officer of DoubleLine Capital, a California-based fixed-income asset manager.

“If there is no debt ceiling passed, it will force the government to essentially implement a de facto austerity program,” Gundlach said.  Payments to many government departments would stop, including those to some defense contractors.   Coupon payments on the Treasury’s debt, however, would continue, he said.

While Treasury investors might receive a short-term reward if no resolution is reached on the debt ceiling, Gundlach was far less sanguine about the longer-term outlook.

“We are getting close to the end of the road” and must forestall a larger crisis caused by the government’s growing debt burden, he said.

I’ll review Gundlach’s short-term and longer-term predictions for the resolution of the country’s mounting deficit problems and how he expects the Treasury markets to perform over the coming year.

The ultimate resolution to the debt problems

Until now, the debt ceiling has been raised to coincide with the growth in federal debt, in what Gundlach called a “cynical exercise” of raising the debt ceiling to the level of the excess borrowing needs of the government.

He called the current situation in Washington “remarkable” in that both parties are “cemented into a debate where the end game is hard to discern.”  Neither party wants to raise the debt ceiling without making progress on reducing the deficit, but their views of how to achieve those dual goals are radically different.

Gundlach said that a debt-ceiling agreement will ultimately be reached, and some tax loopholes will be closed along with some spending cuts in the out years.