Submitted by Taps Coogan on the 15th of February 2019 to The Sounding Line.
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Jeffrey Gundlach, founder of DoubleLine Capital, recently spoke with Yahoo Finance in a wide ranging interview. He warns about the rising US national debt and building financial risks in the corporate bond market.
“… When the Fed says ‘patient’ what they mean is, I think, that they are not going to doing anything unless they say something first… That’s obviously a massive change from the December press conference that Jay Powell gave after the Fed meeting when he said that quantitative tightening was on autopilot. In fact, I just read the other day that the Fed admits they are having discussions about doing quantitative easing again, which is a radical change from saying quantitative easing is on autopilot… They are discussing, they haven’t drawn a conclusion yet…, the idea that quantitative easing will be a regular policy tool. Not one that is used only during emergencies or when you have already gone through the zero interest rate lower bound…”
“I think the biggest risk, and it may not materialize for a little longer, is when the next recession comes there is going to be a lot of turmoil because the corporate bond market is extraordinarily leveraged. The ratings of the corporate bond market are very low. There is a study by Morgan-Stanley Research that if you use leverage ratios alone… 45% of the investment grade bond market would be rated junk right now… So obviously, if there is a recession these ratings will have to be lowered. For now the ratings agencies are listening with sympathetic ears to reassuring statements by some large corporations that they are aware that their leverage ratios are kinda high but they plan on addressing that sometime in the next few years. If there’s a recession, it’s obvious that the leverage ratios will not be addressed and the ratings will have to go…”
“Also, during the next recession we are going to have an extraordinary national debt problem because the national debt is growing at a very rapid rate already and supposedly, if I keep listening to Larry Kudlow and the President, they keep telling me its the best economy ever. I know that they know that they’re being hyperbolic, but it is a growing economy. Real GDP is 3% year-over-year on the most recent reading. And yet the national debt in fiscal 2018, which ended September 30th, was increased by $1.27 trillion. Now the government tells you that the deficit was a little under $800 billion but they’re not really telling you the truth, because the national debt is the debt, and what’s missing from the $800 billion to the $1.27 trillion are things like war expenditures that are deemed to be off-budget, national relief for natural disasters, and loans from the Social Security system which obviously are not real. I mean that’s just one branch of the government funding another branch of the government. You can’t finance yourself. So if we are growing at 6% of GDP, which is what we are really growing at in terms of national debt… during a 3% real economy, what’s the debt going to grow by during a recession? Well, typically the debt-to-GDP ratio goes up by about 4% during a recession. So it suggests that the national debt would grow at around a 10% annual rate if we go into a normal average type of recession. That’s obviously a really big problem. There’s also tons of bonds maturing. The corporate bond market has $700 billion of bonds maturing this year… Maybe long term interest rates won’t fall during the next recession because of the tremendous amount of bonds that will be put into the market. So, I think those are the things, in the longer term, that are the big risks. In the short term, risk sometimes don’t really matter… Back in 2006, the only thing that mattered was that you understood that a credit crisis was coming. I think this time the only thing that really matters is this problem with the corporate bond market and the national debt issue when the next recession comes and that’s really going to trump any kind of short term movements…”
“The indicators that we look at for recession are not even flashing fully yellow yet. It’s more of a yellowish-green right now. We look at things like the Leading Economic Indicators. It’s kinda of the grand-daddy of them all… That, year-over-year, has always gone negative before the front end of a recession, and while its weakening from a very high level, it’s still pretty high at around 5% year-over-year… To look for a recession in the near term, you have to look really hard and with a jaundiced eye. I think right now it’s too early to say that we have the necessary conditions in place for a recession on the foreseeable horizon, which is good news, but the bad part of that news is the foreseeable horizon is typically no longer than… four to six months. “
For whatever it’s worth, we couldn’t agree more. We discuss many of the same national debt and deficit figures in depth in this article: ‘You’d Have to Eliminate 100% of Discretionary Spending to Halt the Growth of the National Debt.’
There is much more to the interview, so enjoy it above.
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