6 % 10 Year?

November 14th, 2016 5:43 am | by John Jansen |

Via Barron’s:

You heard it here first: Jeffrey Gundlach, CEO of DoubleLine Capital and one of the world’s most successful bond investors, predicted in January at the Barron’s Roundtable that Donald J. Trump would be the country’s next president, noting, “The populist momentum is unstoppable.”

Now that the New York businessman has shocked much of the world by vanquishing rival Hillary Clinton, Gundlach sees something else unstoppable: a rise in bond yields that could lift the yield on the 10-year Treasury note to 6% in the next four or five years.


Trump’s pro-business agenda is inherently “unfriendly” to bonds, Gundlach says, as it could to lead to stronger economic growth and renewed inflation. Gundlach expects President-elect Trump to “amp up the deficit” to pay for infrastructure projects and other programs. That could produce an inflation rate of 3% and nominal growth of 4% to 6% in gross domestic product. “If nominal GDP pushes toward 4%, 5%, or even 6%, there is no way you are going to get bond yields to stay below 2%,” he says.

The yield on the benchmark 10-year Treasury bond rose 0.27 percentage point in the two trading days following the election, to end the week at 2.15%.

While the bond bull market ended in 2012, Gundlach says, he turned “maximum negative” on bonds on July 6, two days before the 10-year Treasury yield hit a multidecade closing low of 1.366%. He predicted shortly thereafter that the 10-year yield would top 2% by year end.

After last week’s rapid run-up, Gundlach won’t rule out “a tradable rally in the bond market before year end.” But the longer-term trend likely is higher. “The idea that inflation and interest rates can never go up is a very tired narrative, born of years of stability in both,” he says.

Gundlach, whose Los Angeles firm manages more than $100 billion, has been selling bonds and buying Treasury Inflation-Protected Securities, or TIPS, which he calls “my favorite investment as of two months ago.” The principal of a TIPS increases with inflation, as measured by the consumer-price index.

TIPS are still cheap relative to nominal bonds, despite a recent move up, he says. In August, Gundlach replaced the Treasuries held in the DoubleLine Flexible Income fund (ticker: DFLEX), which he manages, with TIPS, a swap affecting about 10% of the portfolio. He also sold Treasury bonds and bought TIPS in the DoubleLine Core Fixed Income fund (DBLFX). Both funds are beating their benchmarks this year.

IN THE AFTERMATH of Trump’s victory last week, Gundlach commended the long-shot Republican candidate for “playing the electoral game to win,” and cited three reasons for Clinton’s defeat: the WikiLeaks revelations that cast her in a highly unflattering light; votes cast for third-party Libertarian candidate Gary Johnson; and skyrocketing health-insurance premiums on the marketplaces created by the Affordable Care Act, aka Obamacare. Open enrollment in health-care plans began Nov. 1, just a week before voters headed to the polls.

Gundlach says he hasn’t formulated an opinion yet on what’s next for the stock market, partly because of the difficulty of reconciling opposing forces: on the one hand, pro-growth policies, and on the other, higher rates, which would pose competition for stocks. “If rates stay around these levels, it is probably a net positive for stocks,” he says. “But if they move sharply higher, I don’t see how stocks withstand it.”

Moreover, he says, “the structure of the U.S. economy and the pricing of the stock market are predicated on 1.5% Treasury yields and zero short-term interest rates.” Rising rates would hurt the U.S. housing market and possibly dent corporate stock-buyback programs. Buybacks helped boost share prices in recent years and were funded, in many cases, with borrowed money.

While Trump’s policies could stimulate the economy in the near term, the future could look darker, given a potentially “unacceptable” level of debt to GDP. “With rising interest rates and rising debt levels, we are going to have to make some tough decisions,” he says. “What are we going to do in terms of collecting taxes and distributing government revenue? What will we do about Social Security, Medicaid, Medicare? That is what the 2020 election will be about.”

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