Headline CPI rose from 2.5% to 2.74% last month, fueling speculation about higher interest rates. But inflation readings will be lower in the next few months, according to Jeffrey Gundlach.
Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital. He spoke to investors via a conference call yesterday. Slides from that presentation are available here. The focus of his talk was DoubleLine’s asset-allocation mutual funds, DBLFX and DFLEX.
He said that inflation pushed bond rates up in second half of last year. But, he said, “headline CPI will retreat from 2.7% to 1.9% in the next few months.”
The high point for CPI in the U.S. and the rest of the world is “about to be hit in the next month,” he said, “and then it will drop off as data from last year rolls off.”
CPI inflation is calculated by the Bureau of Labor Statistics (BLS) on a year-over-year basis; reported inflation depends only on the current price level and the price level a year ago.
He conditioned his forecast on a continued moderation in oil prices, which he said have settled around $50/barrel, based on the WTI index.
Economists’ forecasts for 2017 nominal GDP are 4.7%, which Gundlach said is a good predictor of 10-year Treasury rates. But with the 10-year at approximately half that value (2.36%), he said that, “It seems that long-term interest rates are too low relative to GDP.”
“Either rates will rise or the forecasts will be downgraded,” Gundlach said.
I’ll look at Gundlach’s assessment of valuations in various sectors of the bond market and at what is driving the rise in equity prices, but first let’s look at the economic backdrop underlying his forecasts.
A synchronized upturn with no recession in sight
For the last month or two, Gundlach said global economies have undergone “the most synchronized global upturn in years.” Some data is even stronger than people realize, he said, such as the European PMI index, which is above zero for the first time since the global financial crisis. That could be a precursor to an ECB interest rate increase, according to Gundlach. The probability of an increase had been as high as 50%, but is now about 20% because rates have risen.
Fears surrounding the Eurozone are “calming down,” he said, as odds for a Marine Le Pen victory in France are fading. But Gundlach said the breakup narrative “won’t end” because of ongoing tensions, such as French unemployment (10%), which is much higher than in Germany (6%). He noted that the price of the 50-year French government bond was up to 120 in July of last year, but when rates rose it went to its current price of 80, which highlights the interest-rate risk in long-maturity bonds.