On the 22nd, DoubleLine's CEO and 'new bond king' Jeffrey Gundlach emphasized in an interview with Drew Watson, an art services expert from Bank of America Trust, that the forty-year era of low interest rates has come to an end, which will completely change investors' past investment decisions.

He predicts that the Fed will cut interest rates once within the remaining time of this year and maintains an optimistic attitude towards next year's inflation rate, expecting it to be below 3%, and believes that the market's concerns about inflation are excessive.

Gundlach is concerned about the U.S. government's debt issue, believing that if the debt size becomes too large, the government may take extreme measures, leading to dramatic fluctuations in long-term Treasury bond prices. He fears that the U.S. could experience a situation similar to three years ago when UK government bond rates rose sharply, firmly believing that interest rates have bottomed out.

It is worth noting that Gundlach believes that market expectations for the Fed have never been so volatile. At the beginning of the year, the market generally expected a significant rate cut by the Fed, but as economic data fluctuated, the expectations for the rate cut were substantially adjusted. In addition, changes in inflation and employment data have also had a significant impact on rate cut expectations.

The key points of the interview are as follows:

• Interest rates have been declining for decades. However, in the past two years, there has been a significant increase in interest rates. Due to the fundamental shift in the interest rate environment, past experiences may no longer apply.

• Three years ago, the UK had to sell some bonds. Overnight, the long-term UK government bond rates rose by 150 basis points, resulting in a huge loss. But what if the U.S. were to experience a similar situation?

• I firmly believe that interest rates have quietly bottomed out. Interest rates will rise again, and some past relationships will completely reverse. People often say that the US dollar will rise in an economic recession, but I think everything will fall in the next economic downturn.

• It is expected that the Fed will cut interest rates once this year, and CPI will remain below 3% by the middle of next year.

• I think many data seems to have been manipulated. This is because there are two different employment reports: one is the institutional employment report, and the other is the household survey report. I am curious why there is such a big difference in the results of these two surveys.

• The federal government's interest expenditure is $300 billion annually. Today, it has reached $1.3 trillion and is still rising. The reason is that between this year, next year, and 2026, there are $17 trillion in bonds maturing, many of which have an average interest rate of 0.2%. So, what we will see is $17 trillion.

• Due to the issuance of a large number of low-quality bonds and the lowering of interest rates, the default rate of corporate bonds this time may be higher than in the past.

• I have been working in this industry for over 40 years, and 30% of the time I am wrong, making mistakes often. But I am right 70% of the time. If you can maintain this state, it's a money-making machine.

The following is the original interview text:

Current low interest rates and long-term quantitative easing policies will accumulate a huge debt burden.

Jeffrey Gundlach:

Most people are unaware that the economic crisis of 1921 was a significant issue. That year, GDP plummeted by one-third. They forced the liquidation of all bad debts and non-performing investments, raised interest rates, and cut government spending, leading to an economic collapse. In fact, the cause of the depression in 1921 was due to these measures being correct. After enduring the pain, by 1923, everything returned to normal. However, when the Great Depression of the 1930s arrived, they took opposite measures, prolonging the Great Depression as a result.

This reflects the situation of our time. In my over 40-year career, whenever faced with economic difficulties, the situation seems to worsen. This is not a coincidence but because they try to prevent economic difficulties, pushing the problem forward.

The zero interest rate and sustained negative interest rate policies adopted last time were terrible. The economy seems to be running well on the surface, but the budget deficit reaches as high as 2 trillion dollars. When an economic recession occurs, the budget deficit will increase as tax revenues decrease, and transfer payments and unemployment benefits increase.

In the recent economic downturn, our budget deficit increased more than the average of the past three economic downturns. The previous budget deficit severely distorted this fact, averaging 9% of GDP. Excluding the COVID-19 pandemic, it is around 7% of GDP. If the 7% of GDP is added to the budget deficit in the next economic downturn, the budget deficit will reach 20 trillion dollars, that is 2.5 trillion dollars, totaling 4.5 trillion dollars.

We discussed this issue at the investment team meeting. Interest rates have started to rise, both in Europe and the USA. Many believe this trend is developing.

Why? What was the catalyst for the significant increase in interest rates from last Friday until yesterday? People are paying attention to this issue because of concerns about debt and its financing methods.

Past experiences may no longer be applicable in the current economic environment.

Jeffrey Gundlach:

Experience might not be a positive factor at this moment, as you and I both have experience. You think you understand how relationships work and can apply past economic experiences to the present, but I must caution you on this. After 2021, interest rates have generally been on a downward trend. Although there are times when they go up, in the long run, they have dropped from 15% to 2.2%.

Therefore, people may believe they understand the changes during an economic recession. I believe this viewpoint is no longer valid, as our interest rates are no longer declining. From 2022 to 2023, rates have risen from below 1% to over 5%. Interestingly, some relationships that were very effective before 2021 are now completely reversed.

I invented a well-known industry indicator, the copper-gold ratio. By dividing the copper price by the gold price, this has been an excellent starting point for determining long-term bond yields over the past 40 years. When arranged, it has been almost consistently aligned. Any deviations at any time are temporary and will eventually realign.

Since 2021, this indicator has almost lost its effectiveness. By the end of 2021, lifelong bond yields had risen about three-quarters, we can call it 5%. The copper-gold ratio shows that bond yields should be below 1. Why is this happening? I believe it's because we are not insurers.

There is a difference between significant increases and decreases in interest rates. In the past, people often bought gold. When there was deflation, people did not want gold. When there was inflation, people wanted gold. There is a certain connection, and people buy gold for speculative or other reasons.

I think people are now almost permanently removing gold from their asset allocation. They are worried that our institutions are collapsing, worried that nobody can get along, worried that we are already involved in two major wars, soon to be three. They worry about our huge budget deficits and worry about election interference. Agencies like the Department of Justice, CIA, and similar institutions all seem to be investing in some way to change the situation.

I think people are concerned about this and anxious about inflation policies. Because when the next economic recession comes, I am unsure what they can do besides the usual plans. The usual plan is to lower interest rates and borrow large sums of money.

In fact, I predict that when the treasury bond rate exceeds 5%, the rate will drop to the middle of 3%. I was criticized for this, but I am right. I think it will happen because when softness appears, people will say they have seen this situation before. As it softens, rates drop, you make money from bonds, and then this situation happens.

But I think the next stage is when the meeting starts, they will say we will not be able to finance these things. Three years ago, the UK had to sell some bonds, and some policy at the time made investors hesitate, not liking the concept. Overnight, the long-term UK government bond rate rose by 150 basis points, which was a huge loss.

This means a loss of 30% overnight. Then they said, it's just a joke. Sorry, the rates eased, started to drop. But what if the USA also experiences this? It will expose a lot of issues.

Therefore, I firmly believe that rates have quietly bottomed out. I think rates will rise again, some past relationships will completely reverse. People often say the dollar rises in economic downturns, I think everything will fall in the next economic downturn. In an economic downturn, emerging markets usually lag far behind the US stock market. But I think the situation will be the opposite because when the dollar falls, if you are a dollar-based investor, you will want non-dollar investments. Ironically, currencies like the peso may actually be more valuable.

Due to the large number of low-quality bond issuances and the decrease in interest rate levels, the default rate of corporate bonds this time may be higher than before.

Jeffrey Gundlach:

There is one more thing, about corporate bonds, people think understanding how corporate bonds operate is important. When the economy is in a downturn, they may default. Historically, these near-bankrupt companies have postponed problems through refinancing. Even though investors demand higher junk bond yield premiums, their benchmark rates are still lower compared to US treasuries.

Therefore, companies borrow at a rate of 8%. When US treasuries fall by 300 basis points and the spread widens by 1%, they can still refinance at a rate of 7%. But now, even with lower rates, with a large number of low-quality bond issuances, they are paying a rate of 3.5%. Such low rates are no longer possible, especially for low-quality bonds. So this time, the default rate may be higher than expected.

Based on experience, I remember that in the first year, the market rose, and interest rates dropped from 15% to 7%. At that time, I thought it was a bit crazy. ICE sold long-term government bonds, and I considered myself very lucky to sell at the absolute highest price. Four months later, the interest rate was 7%, and four months later, the interest rate was 10.43%. At that time, I was still very young and inexperienced.

I talked with a broker who told me that I sold the stocks at a 7% discount. At that time, I was selling top technology stocks. He said I lacked experience, and now I understand he was right because experience can lead to rigid thinking. At that time, I looked at the chart, saw the buy-in from Japan, and sold the stocks, which turned out to be the best trade of my life.

Golak expects the Fed to cut interest rates again by the end of the year.

Drew Watson:

What is your assumption regarding the number of interest rate cuts before the end of this year?

Jeffrey Gundlach:

I think there might be one interest rate cut. This year's Fed outlook is the most unstable. At the beginning of the year, it was widely believed that the Fed would reduce rates by 2.25% in 2024. However, by the end of March, people started worrying about the resurgence of inflation, unexpected growth in the first quarter, some growth in the second quarter but not as severe as the first quarter. The growth in the third and fourth quarters is normal. Therefore, my forecast has dropped from 7 to almost zero, with almost no rate cuts.

Then the situation weakened, and we received some bad job reports. Expectations for interest rates are no longer for 2024 but for the next 12 months. For a while, the market expected 10 rate cuts, totaling 250 basis points, which caused panic at the Fed. The market suppresses the rates; they dislike the gap between overnight rates and two-year Treasury rates. They follow the two-year Treasury rate.

We do not need the Federal Reserve, but we need Bloomberg Terminal, because the 2-year US Treasury yield leads the Federal Reserve. They deny this, but in fact they follow the Treasury yield. There is a gap, so two days before the Federal Reserve meeting, I predicted that they would cut interest rates by 50%. On July 31st, they cut interest rates by 50% on several occasions, indeed cutting rates. Now, we have a better employment report.

Many people are worried that inflation has not subsided yet. I do not think so. According to my forecast, the CPI will stay below 3% at least until the middle of next year. This should give the Federal Reserve more confidence.

The government's employment report and statistics have been "manipulated".

Jeffrey Gundlach:

I believe these numbers are exaggerated, many data seems to be manipulated.

Another thing that cannot be ignored, because there are two different employment reports. One is institutional employment reports, released every first Friday of the month. In recent years, this report has been revised down multiple times, causing concern. A revision is made every year. Recently, they cut 0.818 million job positions, so the original number is not accurate. The other is the household survey report, which is more accurate than the institutional survey at economic turning points. The household survey for the first nine months of this year shows that the cumulative number of employment positions has not increased, and since then the cumulative number of unemployed people has been negative. Full-time employment is negative every month. As for part-time work, although it fluctuates, the employment growth so far this year is also negative.

I am curious why there is such a large difference between these two surveys. But I do think the Federal Reserve may cut interest rates. Unless the market further recovers, they may cut rates, and the next Federal Reserve meeting is only two weeks away.

I am curious why there is such a large difference between these two surveys. But I do think the Federal Reserve may cut interest rates. Unless the market further recovers, they may cut rates, and the next Federal Reserve meeting is only two weeks away.

The spread between the federal funds rate and the term rates is$American Financial (AFG.US)$the largest in market history. Compared to the federal funds rate, term rates have never been so low, with a significant gap. This further indicates that there is some catching up to do.

Finally, the Fed cut rates by 50 basis points, but in previous meetings, they did not take any action on a 50 basis point cut. The two-year Treasury rate fell by 62 basis points. They cut rates by 50 basis points. This means that no matter how far behind the curve they were on July 31, they are now even further behind the curve. Rates have recently rebounded, but as of the last Fed meeting, they were actually 50 basis points behind the curve. So we'll see what happens, but the Fed will cut rates.

The scale of U.S. government debt is huge and growing rapidly, potentially facing enormous pressure on interest payments in the future.

Jeffrey Gundlach:

I really don't like long-term bonds. I've taken some measures to protect clients from the impact of certain market reactions I'm concerned about. In the past 20 to 25 years, we've seen many reactions like this.

The earliest was in the early days of the economic crisis, when the auto industry was highly leveraged, leading to Ford's bankruptcy and General Motors on the brink of bankruptcy. General Motors had a heavy debt burden, with some debt prioritized over other companies. The government's solution was to place General Motors' pension system ahead of secured bondholders, thus rescuing the General Motors pension system. Legally, these bonds should have priority, but they were placed below the pension system, causing bond prices to plummet. Although illegal, this may have been done for political reasons.

Subsequently, we encountered mortgage issues involving a large number of subprime and zero down payment mortgages. These loans were packaged into securities and traded publicly. The prospectus clearly stated that the terms, rates, and maturities of the mortgages could not be modified. Many investors believed these assurances, but I was not one of them. When house prices fell by 35% and loan-to-value ratios exceeded 100, they decided to modify the terms, despite threats of lawsuits from several investment firms, they could not fight against the government.

In 2020, to cope with the lockdown, the corporate bond market collapsed. According to the Federal Reserve Act of 1913, it is illegal for the Fed to buy corporate bonds. However, during the global financial crisis, there was intense internal debate at the Fed about this, ultimately deciding not to do so. But this time they bought corporate bonds, causing market prices to quickly rebound. The Fed pledged to buy back bonds at face value, causing prices to surge significantly within a few weeks.

What happens when politicians do not discuss this issue? Four years ago, we encountered an interest payment problem. The federal government's interest payments amount to $300 billion annually. Today, it has reached $1.3 trillion and is still rising. The reason is that between this year, next year, and 2026, $17 trillion in bonds will mature. Many of these bonds have an average interest rate equivalent to the five-year bonds issued in 2019, with a rate of 0.2%. This rate is lower than not long ago but has risen by almost 5%. So what you see is $17 trillion.

Not all bonds have such low interest rates, but I think the average rate is around 3%. Even if we issue bonds at around 4% now, rates are still rising. So people are talking about interest rates. What happens when the next economic recession pushes the deficit up to $5 trillion? Some say, I will not buy bonds at 3% because you have issued $5 trillion and are implementing inflation policies through deficit spending and lowering rates. I think there may be an on-the-spot auction.

So I did one thing, I said to myself, my backup plan is to invest in two undisputed pillars. One is don't take risks unless you are rewarded for it. The other is to eliminate risks if you can do so at little or no cost.

All of this happened to me. I was in Toronto at the time, and I'm going there tomorrow. I said to myself, why don't we keep the maturity structure of government bonds exactly the same, but instead, for example, we buy 20-year bonds, sell 20-year bonds, and buy the bonds with the lowest interest rates, which are what we call the bonds with the lowest face value rate.

It took us about two weeks because we did it discreetly. We did not want this to leak out. Within a few weeks, we got our long-term bonds.

I'm not predicting that this situation will occur, but if you can eliminate risks at no cost, then go ahead. In this case, I eliminate risks at a negative cost because this swap from one bond to another actually creates a slightly higher yield because we call it a "run stop." Liquidity decreases.

If they announce that we will make some minor adjustments because we cannot afford the 4% interest payments on $40 trillion in bonds. We would say if your bond contract pays over 1% interest, it is now 1%. If you pay less than 1%, it remains the same. Since interest payments may be 4%, reducing them to 1% cuts interest payments by 75%. This is a way to pass the problem to the next government, the next congress. Everyone will cry, except me - I will sit there and say, wow, we are heroes. Because if this happens, some people could lose 30%, 40%, 50% overnight.

Drew Watson:

So, where are you positioned on the yield curve?

Jeffrey Gundlach:

In fact, I actively short and long long-term bonds by buying 2-year, 3-year, and 5-year bonds to gain interest rate exposure. So, I actually have a quasi-trade. Right now, I am short 20% and 30% of U.S. Treasuries and long 2% and 3% of U.S. Treasuries on a leveraged basis. This has not worked out in the past few weeks but has been effective over the past few months.

I believe that the bond market is different from the past. In the past, the bond market had very large trading volume. However, regulatory agencies later introduced a series of regulations such as the Dodd-Frank Act and the Elizabeth Warren Act, electronic trading became more common, leading to a significant decrease in trading volume.

Sometimes liquidity is good. September saw the largest bond issuance in U.S. history, especially the largest corporate institutional bond issuance, oversubscribed at the time. People wanted more, so liquidity was very high, but sometimes there were issues, and sometimes not even a penny could be obtained. So, you need to take advantage of these moments of liquidity to switch to something more liquid, while combining things with serious economic risks, like 3C corporate bonds, which are very expensive.

This is currently the most expensive non-energy moment. We exclude energy because energy is really valuable. If you take out energy from corporate bonds, the additional yield you get from buying corporate bonds is historically the lowest. I think there is a reason for this. I think you may not be able to trust the government's debt management, which supports the idea that companies should generate the least additional yield. When I started my career, some corporate bonds had lower yields than government bonds because people did not trust the government.

The meaning of investment: is to figure out what you think you understand and how to achieve it.

The meaning of investment is to understand what you think you understand and how to achieve it. This cannot be taught. Either you are interested in and capable of thinking in this way, or you don't like it or you're not capable. So I have done a lot of this kind of thing. Many people ask me why I have nothing except that bond. I say you don't understand investing. When you manage other people's money, you cannot take deadly risks.

One small thing I try to teach young people is to admit "I know I make mistakes sometimes". Make sure the mistakes are not fatal. If you only buy one-third of government bonds, if you're right, you may get attention, but if you're wrong, you're bankrupt. Never take portfolios with fatal risks.

You need to start thinking about your investment portfolio, such as, how do I handle this issue? Assuming I'm wrong, the situation would be bad, but can we survive? No fatal risks. That's the meaning of "Double I". In the real world, there is something called "Double Line". It's a road you're not allowed to cross. If you cross the middle, you'll be fined. But they don't really want the income, they are trying to protect you from a head-on collision when turning. So the whole concept of "Double Line" is no fatal risks. You can't cross the double lines. It also means you have to consider, what can I do if I'm wrong in a specific activity in the investment portfolio, will this work? This way we can suppress overall volatility together.

So I've been working in this industry for over 40 years. I'm wrong 30% of the time. It's been more than 10 years, actually more than 12 years, when I was wrong. So I make mistakes often. My competitors always like to point out when I'm wrong. I say, yes, of course. But 70% of the time I'm right. If you can maintain this state, that's a money-making machine. Working is about striving to maintain this state.

Editor/Rocky