Gundlach: Fed will be in "Panic Mode" When a Recession Hits

If the signs of a recession, like weakness in trucking volume and manufacturing PMIs, prove true, the Fed will be in panic mode, according to Jeffrey Gundlach. The economy will weaken, rates will go up and the Fed will have to “do something,” to protect against a “spiral” of higher rates feeding and slower growth.

Gundlach is the founder and chief investment officer of Los Angeles-based DoubleLine Capital. He spoke to investors via a conference call at 4:15pm on July 23. The focus of his talk was DoubleLine’s fixed-income closed-end funds, DBL and DSL.

Gundlach devoted most of the call to the positioning of DBL and DSL. I will focus on the last 15 minutes of the call, when he took questions from the attendees, with the focus on a possible recession and the direction of interest rates.

Gundlach predicted a “high likelihood” of a recession before 2020 election. The leading economic indicators (LEIs) also point to a weakening economy. As rates rise, so will interest costs incurred by the government, which would translate to further weakness in the private sector. The underlying problem causing the spiral is the large and expanding federal deficit, according to Gundlach.

“We’re starting out before the recession with a huge debt problem,” he said, “that will grow faster in a recession.”

In response, Fed policy has become more “evolutionary,” he said. It has been talking about quantitative easing (QE) as a “normal” policy tool, instead of one whose use is restricted to crises. The Fed is softening people up, he said, so that if rates rise, it will do QE and then emulate the Bank of Japan and other central banks to take rates negative.

A reason rates are so low is that the Fed is “hedging its bets,” Gundlach said. Rates will go up first as the economy weakens and be engineered down. This pre-emptive rate reduction could leave the Fed with nowhere to go, as a recession demands ways to stimulate growth.