Gundlach v. Yellen: Will the Fed Raise Rates?

Jeffrey Gundlach On Friday, Fed Chairwoman Janet Yellen said that the nine-year wait for an interest-rate increase would likely end this year. Three days earlier, though, Jeffrey Gundlach said that a rate increase this year is unlikely, given the mix of bad news and uncertainty in the world markets. Which view prevails will be the focus of bond market participants in the months ahead.

Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital, a provider of fixed-income mutual funds and ETFs. He spoke to investors via a conference call on July 7. Copies of the slides from his presentation can be found here.

“With the Shanghai price movement and what is going on in Greece and Puerto Rico and other places, it is increasingly unlikely that the Fed is going to be raising interest rates in September,” Gundlach said. There is consensus; he said the futures market is pricing in less than a 50% chance of a Fed hike at its next meeting, in September.

Yellen, however, said that “it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy." But, perhaps mindful of the factors Gundlach cited, she added, "I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step."

Gundlach also offered some asset-class forecasts and predicted the Greece would leave the euro. But, first, let’s look at what he said are the key issues that will influence the Fed’s rate-increase decision.

The odds of a Fed rate hike

For the last four years, the Fed has been consistently downgrading its economic forecasts, as can be seen in the chart below:

Fed's Growth Outlook

The orange line shows the Fed’s forecast from 2013 to 2015. It started less optimistically than in the prior two years, and has been declining steadily. It is now lower than at any time during 2013 or 2014, Gundlach said.

“It is remarkable that people are talking about the Fed raising interest rates when the Fed’s own forecast for 2015 growth is lower than it has ever been and lower than the actuals for 2013 and 2014,” he said.

An unbiased observer would surely advise the Fed to ease – and not tighten – credit conditions based on this data, Gundlach said.

Gundlach repeated what he has said in the past, “The Fed does not want to be at zero. It’s looking for reasons to do it. But this exhibit certainly does not give them any such reason.”