Gundlach Says Fed May Expand Balance Sheet After Repo Moves

(Bloomberg) -- The spike in overnight repurchase agreements may prompt the Federal Reserve to expand its balance sheet, according to Jeffrey Gundlach, chief investment officer of DoubleLine Capital.

“Is it an imminent disaster? No. The Fed is going to use this warning sign to go back to some balance sheet expansion,” Gundlach said Tuesday during a webcast for his $54 billion DoubleLine Total Return Bond Fund. It’s a way of “baby stepping” to more quantitative easing, he added.

The Federal Reserve injected $75 billion into U.S. money markets Wednesday to quell the surge in rates on one-day loans backed by Treasury bonds, known as repurchase agreements. That followed Tuesday’s $53 billion liquidity injection. The Fed is likely to start expanding its balance sheet to “try to free up the plumbing of the banking system,” the money manager said.

The moves may encourage the Fed to embark on “QE lite,” he said.

The Federal Reserve Open Markets Committee is widely expected to cut its benchmark rate 0.25% when it meets Wednesday, the second reduction this year. The bond market reflects two more Fed cuts this year and one in 2020, he said.

Bond market expectations more than economic need are driving the Fed’s move to reduce rates, Gundlach said Wednesday on CNBC. He said the policy makers shouldn’t cut rates but will.

“The Fed doesn’t need to cut interest rates,” he said. “I don’t see what the real urgency is.”

On the macroeconomic scene, Gundlach reiterated his view that chances of a U.S. recession are 75% before the November 2020 presidential election. Once a recession does come, Gundlach predicts that there will be an explosion in the national debt.

Gundlach also warned of the recession likelihood last week, citing signals including the August yield-curve inversion that has resteepened this month.

DoubleLine Total Return, which invests mostly in mortgage-backed securities, returned about 5.4% this year through Sept. 17, better than 72% of its Bloomberg peers. Its five-year annual average return is 3.4%, better than 82% of rivals.

Here are some other highlights from the webcast:

• “It’s not a great idea to be betting on lower interest rates.” He added that investors have probably seen the low of the year in benchmark 10-year yields, which sank to a multiyear low of 1.42% earlier this month.
• Fed policy makers will probably say as little as possible at Wednesday’s meeting. “I can guarantee you won’t hear ‘mid-cycle adjustment’ from Jerome Powell and the Fed” on Wednesday, he said.
• Gundlach put the chances of a U.S.-China trade deal before the 2020 U.S. presidential election at almost zero. He said China has no incentive to make a deal before the election.
• Bad news for the U.S. dollar: the next big move for the currency is down, Gundlach said, adding that investors should be diversifying into other currencies and markets.
• He’s also less positive on gold in the short-term. But for a permanent portfolio position, gold should be held, he said, adding that “now is the time to be looking for a better buying opportunity in gold.
• If the Democratic primaries were held today, Gundlach said he thinks Elizabeth Warren would win the presidential nomination. “It’s not going to be Joe Biden.”

--With assistance from Melissa Karsh.

To contact the reporters on this story: John Gittelsohn in Los Angeles at johngitt@bloomberg.net;Katherine Greifeld in New York at kgreifeld@bloomberg.net

To contact the editors responsible for this story: Alan Mirabella at amirabella@bloomberg.net, Josh Friedman, Vincent Bielski

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