Gundlach: What Everyone Gets Wrong

September 14, 2015 The flip side of all this is a persistently strong U.S. dollar, right? What does that mean for the U.S. economy going forward?

Gundlach: We’re already seeing that multinational companies are having trouble with the translation of profits from foreign currencies into the U.S. dollar. What it means is that the U.S. competitive position in certain industries, and for multinationals, is getting more challenging. It also means that the U.S. inflation rate is going to have a hard time gaining traction, because a strong dollar is obviously a vehicle to import deflation, or at least disinflation. That’s been the consequence of a stronger dollar.

Now, the dollar was smoking hot from June 2014 until March of this year in a nonstop appreciation. After the dollar got so strong, it became problematic for the Fed, which wants to raise interest rates.

The Fed doesn’t have any fundamental reason to raise interest rates, but they're very nervous about being at zero for so many years, and how it ties their hands, should the economy weaken, which it appears to be happening globally.

Starting on March 18, Janet Yellen showed that they were thinking that the dollar might become a new issue for them, and it might cause them to have to wait in terms of raising interest rates. Ever since then, the dollar has moved sideways.

But we’re in a funny kind of circular logic world, where, since the Fed acknowledged a strong dollar could become a variable, that meant the odds of the Fed increasing interest rates declined. One of the reasons the dollar stopped strengthening is the consequence of the Fed mentioning its strength has been problematic, meaning there's less likelihood of them tightening. But the reason the dollar was getting so strong was that the Fed was talking about tightening.

You see the circular logic: The dollar is strong, so they can't tighten. So the dollar weakens, so they can tighten. So the dollar strengthens, so they can't tighten, so the dollar weakens, so they can tighten. And around we go. That’s where we are right now. What happens next?

Gundlach: It’ll have to break out one way or another, and we’ll let the market tell us which way. I don’t always have a view on where things are going to go. And much of the time, you don’t need to have a view, you need to watch the signals of the market.

Long [duration] bonds want the Fed to tighten. The long bond wants there to be deflation. Why else would you buy a long bond yielding 3 percent, other than there's a strong likelihood of zero inflation or negative inflation? If you think inflation is going to be 2 percent, you probably have no interest in a 2.75-percent-yielding 30-year Treasury bond, and certainly have no interest in a 2-percent-yielding 10-year Treasury bond.

The long end of the bond market—perversely, versus the way people think about it—rallies when the Fed is about to tighten, or is perceived to be more likely to tighten. And it struggles even in the face of high-stock-market volatility, when they think the Fed is less likely to tighten. That’s the Rosetta Stone right now to figuring out how the markets are behaving. Most people don’t get this.

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