Jeffrey Gundlach Speaks at the Buffalo AKG Art Museum
What this covers
In a conversation at the Buffalo AKG Art Museum with Drew Watson, Art Services Specialist at U.S. Trust, Bank of America, DoubleLine CEO Jeffrey Gundlach discusses his near-term outlook for Federal Reserve monetary policy, the prospects for sub-3% inflation into next year, a secular change in interest-rate regime rewriting the behavioral rules of markets and the potential for a failed Treasury auction. The discussion was recorded Oct. 22, 2024.
Highlights from Mr. Gundlach’s talk:
(0:10) The forgotten depression of 1921 and the failed course of U.S. recession policy since then.
(2:53) The “most important investment concept”: the idea that in the midst of an end of a four-decade secular regime of lower interest rates and a rewriting of the developed world’s social and economic order, past experience often will mislead investors in their decision-making.
(4:59) Gold as a “permanent asset allocation amid fears across many fronts, including imploding institutions; U.S. involvement “in two significant wars” on its way to three; massive budget deficits; institutions such as the CIA and Justice Department meddling in elections; inflationary policy.
(6:01) The end of “the old game plan” by which the U.S. government collapsed interest rates to borrow its way out of recessions.
(8:01) In the absence of lower Treasury rates off which corporate spreads price, corporate bonds in the next recessions are headed toward “a much higher default rate than what we think we know from experience.”
(10:53) The outlook for Federal Reserve rate cuts for the remainder of 2024.
(13:04) Jobs reports by the government and indications the statistics are being manipulated.
(15:44) Inflation outlook: “A lot of people are worried that inflation isn’t dead yet. I’m not in that camp.” DoubleLine has “been pretty good on inflation forecasts, and we think we’re going to be living in somewhere below 3% on the CPI at least until the middle of next year.”
(16:07) The vulnerability of longer-term Treasury bonds to “crazy” government actions once the size of the federal debt exceeds critical thresholds. Mr. Gundlach cites past illegal policy actions such as the subordinating of senior secured General Motors debt to bail out the GM pension system and the Fed’s purchase of corporate bonds in 2020 in response to the collapse of the corporate bond market.
Source description (no synthesized summary yet).
The speaker argues that secular interest rate rises have fundamentally broken historical economic relationships, making past experience dangerous for investment decisions, and that future recessions will require unprecedented fiscal and monetary responses that could trigger novel financial market failures including bond auction failures and debt restructuring.
- Four decades of falling interest rates created misleading patterns (copper-gold ratio, recession dynamics, corporate refinancing) that no longer apply in a secular rising-rate environment
- Government debt dynamics have shifted dangerously: $17 trillion of bonds maturing 2024-2026 at rates rising from 0.2% to ~5%, with interest expense growing from $300B to $1.3T annually, making fiscal sustainability questionable
- Policy-maker responses over 20+ years (auto bailout subordination, mortgage modification, illegal corporate bond purchases) signal willingness to breach investor protections, increasing tail risks like forced debt restructuring or failed Treasury auctions
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The Depression of 1921 saw GDP decline by one-third, but because policymakers allowed liquidation of bad debts and bad investments through austerity (raised interest rates and cut government spending), the economy recovered strongly by 1923, whereas the Great Depression in the early 1930s was prolonged because policymakers did the opposite.
“most people don't know that the depression of 1921 was such a such a huge economic problem GDP declined a third in 1921 a third but they they let it happen they they forced all of the bad debts and bad Investments to get liquidated and so they actually raised interest rates and cut government spending and the economy collapsed but the reason that nobody knows about the depression of 1921 is that's the right thing to do you take the pain because by 1923 everything was going swimmingly again but a turnaround and when the when the when the depression came in the early 30s they did the opposite and the depression went on and on and on”
In 2020, the Federal Reserve illegally purchased corporate bonds despite it being prohibited by the Federal Reserve Act of 1913. During the Global Financial Crisis, Fed officials debated breaking the law but decided against it; in 2020 they did it anyway. The mere announcement of Fed corporate bond purchases at face value caused corporate bond prices to jump up to 30-40% in a few weeks.
“it is illegal for the fed by the Federal Reserve Act of 1913 which was made in jeal Island at John Albright's place right it's illegal for the FED to buy corporate bonds and in the global financial crisis I know some people who were at the FED at the time she said they had heated debates about should they ignore the law and Buy corporate bonds and they collectively said we just can't do that this time they did so now the FED illegally bought some corporate bonds it turned out they'd have to buy very many it was just the threat right because the prices went down by 40% and the FED shows up and says oh don't worry about it you know we we're buying them back at face value and so suddenly suddenly the prices went up by you know many percentage points in just a few weeks”
If you buy 100% of a portfolio in a single bet (30-year Treasuries), you might have your 'name up in lights' if right, but you will be 'out of business' if wrong. Portfolio construction must assume you are wrong sometimes and size positions so that losses are survivable.
“if you buy nothing but the 30-year treasury bond you you could have your name up in lights if you're right but you're out of business if you're wrong right never take a portfolio mix you start out thinking about your portfolio say how am I approaching this now let's assume that I'm wrong it's going to be bad but how bad will we be able to survive this no you know no fatal risk”
Job reports have been systematically inflated. The establishment survey is revised down heavily (most recent yearly revision cut 818,000 jobs). The household survey, more accurate at economic turning points, shows cumulatively zero job gains in the first nine months of 2024, with negative full-time job growth every month and negative part-time job growth year-to-date.
“there's a lot of Statistics that look like they're being manipulated so another thing you can't have confidence in because there's two different job reports one is establishment that's the one that comes out the first Friday of every month and gets all the attention that's been revised down so many times in the past couple of years there's a yearly revision the most recent one they knocked off 818 818 100,000 jobs so it was like almost a million jobs and so the initial numbers are no good there's there's another one that's called the household survey which at economic turning points is more accurate The Establishment survey the household survey has for the first nine months of this year cumulatively no job gains job losses cumulatively for nine months from on on on full-time jobs has been negative every month”
In a recession, the U.S. budget deficit increases by an average of 7-9% of GDP (even excluding COVID), which would add roughly $1.5 trillion to the current $2 trillion deficit, bringing it to approximately $3.5-4.5 trillion in the next downturn.
“in recent recessions we've had the the um budget deficit increase by on average the last three recessions now this is distorted meaningfully by the last one which was so unusual but the budget deficit has gone up 9% of GDP on average if we take out covid we could say it's maybe you know 7% of GDP but if we tack on 7% of GDP to our budget deficit in the next recession you're talking about something like another 20 2 and a half trillion so now it would be a $4.5 trillion do budget deficit”
During the mortgage crisis, mortgage-backed securities had prospectuses stating that mortgage terms 'cannot be modified under any circumstances,' but when housing prices fell 35% and homeowners were at 100% LTV, the government modified the mortgages anyway. Investors who threatened to sue could not do so because 'you can't sue the government.'
“those loans were a couple trillion of them were packaged into Securities they were bundled and sold off as publicly traded Securities and there's prospectuses for these Securities and the prospectuses said these mortgages cannot be modified the terms of the mortgages the the interest rate and and the maturity cannot be modified under any circumstances that's what it said in the perspectus is and a lot of investors trusted those assurances I was not one of them trusted those assurances and so when it got really bad and looked like you were going to have on mass defaults because people the housing prices dropped 35% and PE people were doing 100 LTV they said W we're going to modify them yeah”
The federal government's annual interest expense has grown from $300 billion four years ago to $1.3 trillion currently and is rising in a straight line. This is driven by $17 trillion of bonds maturing between 2024-2026 with old coupon rates (e.g., 2019 issuances at 0.2% now needing to refinance at ~5%).
“four years ago the interest expense for the federal government was $300 billion per year today it's 1.3 trillion and Rising straight up so and the reason for that is there are7 trillion dollar of bonds maturing between this year next year and 2026 17 trillion and the average interest rate on many of those bonds have interest rates well they take the five years that were issued in n in 2019 they had an interest rate R of 0.2 that interest rate is is lower than it was a little while ago but it's up near five”
Interest rates have recently begun to rise (as of the speech date) after 40 years of secular decline from 15% in the early 1980s to near 0% in 2021, and the catalyst for the recent rise is concern about the government's ability to finance massive debt loads.
“interest rates have started to rise they're going up in Europe they're going up here and a lot of people are now the The Narrative is starting to develop this developed yesterday why what was the Catalyst for rates to go up meaningfully between last Friday and yesterday and the reason that people are toying with is they're saying people are worried about all of this debt and how are we going to finance it”
In the early 2000s auto crisis, the government subordinated GM senior secured bondholders to the GM pension system by placing the pension as the most senior part of the capital structure, which was illegal but done for 'voter block reasons.' This caused senior bond prices to collapse.
“the Auto industry was heavily overleveraged they got into trouble um Ford actually went bankrupt and GM was on the edge of bankruptcy and GM had a lot of debt and some of it is senior to others so the the bond market works and what they did the government did is they bailed out the GM pension system by putting the GM pension system as the most senior part of the capital structure in front of the senior secured Bond holders they're by law at the front of the bus but they subordinated them to the pension system those bonds just collapsed in price that's an illegal thing to do but they did it for probably you know voter block reasons”
The bond market has changed structurally: Dodd-Frank and other regulations reduced ferocious trading volumes, electronic trading became prevalent, and trading volume collapsed. This creates two dynamics: (1) liquidity is periodically very good (allowing portfolio rebalancing), and (2) other times liquidity evaporates and trading becomes very difficult.
“the bond markets different than it used to be it used to be that there was ferocious volumes of trading but then The Regulators came in with you know Dodd Frank and Elizabeth Warren and all that stuff they piled on a whole bunch of regulations and electronic trading has become much more prevalent and so the volume of trading has collapsed so there are times when liquidity is really good this is one of those times”
Over the speaker's 40+ year career, recessions have gotten progressively worse because policymakers consistently try to prevent them through stimulus ('kicking the can down the road'), which defers pain rather than resolving it.
“in my career which is over 40 years increasingly when we hit economic hard times first of all the recessions seem to be getting worse every time and that's that's not that's not a coincidence it's because they try so hard to Stave them off Kick the Can down the road”
The CPI is seasonally adjusted but the adjustment is done 'very poorly,' creating a consistent pattern where the first quarter surprises to the upside, the second quarter surprises less, and the third and fourth quarters surprise to the downside. This makes early-year inflation scares unreliable for annual policy forecasting.
“you know investment people the CPI is seasonally adjusted but they do a very poor job of it so there's an ongoing pattern perennially of the first quarter surprises on the upside the second quarter surprises but not as much as the first quarter and the third and fourth quarter surprise to the downside”
The 'Switcheroo' scenario resembles Byron Wien's 'surprise list' concept: a prediction that doesn't need to have 50%+ probability to be worth hedging against, only higher probability than consensus expects. Wien looked for ideas with ~30% actual probability that consensus thought had 5-10% probability, and was right about 3-4 out of 10 predictions.
“I think this is a Byron wean surprise thing there kind Nam Byron we who was a legend in the investment business at the end of every year who put Byron we's 10 surprises for the new year and he used to explain it by saying I don't believe these are 50% plus chances I just believe that the chances of these things happening is higher than what the consensus believes so he would look for ideas that he thought had maybe a 30% chance of happening that most people thought had a five or 10% chance and he would be right on these things you know maybe three out of the 10 four out of the 10 that's what I think of here will it happen I don't know but eliminate a risk at no cost”
Excluding energy (which is volatile), non-energy corporate bonds are yielding the least premium over Treasuries in history—the 'spread' is at an all-time low. This expensive valuation makes sense if investors doubt government debt management but fear corporate defaults more, so they accept lower yields for corporate credit quality.
“this this is this moment is the most expensive non-energy we take out energy because it's really volatile um if if you take energy out of corporate bonds the the extra you get for buying corporate bonds is the Le least it's ever been in history ever if you take out energy uh and I think there's a reason for that”
Two foundational pillars of investing are: (1) don't take a risk unless you get paid for it, and (2) if you can eliminate a risk at little or no cost, eliminate it.
“there's two non-controversial pillars of investing money the first is don't take a risk unless you get paid something for it pretty noncontroversial another one is if you can eliminate a risk at very little or no cost eliminate the risk”
Portfolio construction requires that if you take on a particular risk exposure in one part of the portfolio, you must also construct offsetting positions such that if you are wrong on that exposure, the offsets will work and dampen overall portfolio volatility.
“you also means that you have to think about if I'm doing this particular activity in part of the portfolio what can I do that if I'm wrong this will work and so that together we can dampen the volatility of the overall so”
The Federal Reserve follows the two-year Treasury yield more than it leads it. The market (represented by 2yr yields) determines Fed expectations, not vice versa. The Fed denies this publicly but the speaker asserts they are 'lying' about it.
“they don't like it when there's a big gap between their overnight rate and the two-year treasury rate they follow the two-year treasury we don't need the FED we need a Bloomberg terminal because the two-year treasury the the two-year treasury leads the FED they deny it until they'll till they're blue in the face but they're lying they do follow the two-year Treasury”
The breakdown of the copper-gold ratio's predictive power is because gold buying behavior has changed from speculative/inflation-hedging (responding to inflation vs deflation concerns) to permanent asset allocation driven by structural concerns: institutional worry about imploding institutions, inability of political leaders to cooperate, multiple significant wars, massive budget deficits, perceived election meddling, and fear of inflationary fiscal policy responses.
“I think it's because we're not in there's something different about secularly Rising interest rates versus falling so people used to buy you know people gold used to be oh uh you know there's there's deflation I don't want gold there might be inflation I want gold it would be it would it had some sort of a connection that people were buying it out of speculation or something now I think people are buying gold out of almost permanent asset allocation they're worried they're worried that our our institutions are imploding they're worri that nobody can get along they're worried that we have uh we're we're in involved in two significant Wars it's going to be three soon you know they're they're worried that we have this massive budget deficit we're worried that that it looks like there's meddling around in elections that looks like the doj the CIA I mean all of them they all seem to be invested in sort of tipping the scales of things and I think people are worried about that and they're worried about inflationary policy because when the next recession comes I don't know what else they're going to do except except the old game plan”
Current policy maintains an economy with a $2 trillion annual budget deficit using near-zero interest rates and negative real interest rates on a sustained basis, which is 'terrible policy'.
“what we did last time with zero interest rates negative interest rates on a sustained basis this is terrible policy and we're running an economy that's supposedly good with a with A2 trillion budget budget deficit”
The next recession will be different from historical recessions because when weakness arrives, investors will no longer assume 'the old movie' (economy weak → rates fall); instead, they will worry about the government's ability to finance its massive deficit through new bond issuance at current yields, potentially leading to failed Treasury auctions and forced debt restructuring.
“I think now the next stage is when the recession comes they'll say we're going to we we can't Finance this stuff so there was a moment in the UK three years ago where they they had to sell some bonds and there was some sort of policy that was being uh considered that investors bulked at they didn't like the concept and overnight the interest rates went up on the long-term uh guilts the UK bonds they went up by 150 basis points overnight which is a massive loss I mean you're talking about a 30% loss overnight”
Experience over 40 years of falling interest rates may not be a positive guide for the present moment because interest rates are now secularly rising, and historical relationships that worked in a falling-rate environment will reverse or become unreliable in a rising-rate environment.
“I would add one note of caution on doing that 40 years into 2021 there was nothing but Falling interest rates yes they went up sometimes but out of General sense trending secular trend from 15% rates to 02 and so people think that they understand what happens during a recession I don't think that's going to work because I don't think we have falling interest rates anymore”
Interest rates have 'secularly bottomed' and are now in a period of secular rise; therefore many historical recession relationships will reverse in the next downturn: people will say the dollar will go down (not up), Emerging Markets will outperform (not underperform), and non-dollar investments will be more attractive.
“I'm strongly of the opinion that interest rates have secularly bottomed I think that they're going to be secularly rising and you and some of the relationships from the past will be exactly the opposite mapping of the future people say in recession the dollar goes up I think the dollar is going to go down in the next recession in the in in recessions Emerging Markets greatly underperform the United States stock market I think it's going to be the opposite because when the dollar is is is going down down down if you're a dollar-based investor you want non-dollar Investments”
In the next recession, if someone says they will not buy U.S. Treasury bonds yielding 3% while the government is issuing $5 trillion of them and running inflationary deficit spending, a Treasury auction could fail, creating a tail risk that markets are not currently pricing in.
“what happens in the next recession when the deficit goes up to5 trillion and there's somebody says I am not buying 3% bonds where you're issuing five trillion dollar of them and you're running an inflationary policy through deficit spending and no doubt at least initially lower interest rates I think there's going to be the potential for a failed auction”
Historically, companies approaching bankruptcy could 'kick the can down the road' by refinancing debt at higher spreads because the base rate (Treasury yields) was falling fast enough to offset the spread widening. For example, a company borrowing at 8% could refinance at 7% when Treasuries fell 300 bps even if spreads widened 100 bps. But this will no longer work for lower-quality bonds because many low-quality bonds issued at 3.5% will never see that rate again, making default rates much higher than historical experience in the next recession.
“historically has been because the companies that were getting closer and closer to bankruptcy were able to Kick the Can down the road by refinancing even though investors demanded more yield premium from junkier bonds the base rate off which they're compared the treasuries were lower so companies that had borrowed at 8% so rates on treasuries Fall 300 basis points spreads wide out by a couple percent they still can refinance at seven they can't do that now because even though rates have come down a great quantity of of lower quality uh Bonds were issued where the interest rate they were paying was 3 and a half% you will never have those interest rates on on particularly the lower quality bonds they'll never see 3 and a half% again”
The concept of 'double line' (from road safety metaphor) represents the idea of no fatal risks: a road's double yellow line prevents head-on collisions by preventing drivers from crossing into oncoming traffic on a windy road. Similarly, investment portfolios need a 'double line'—a boundary that prevents positions from becoming so large that a wrong call would be catastrophic.
“there's there is a thing in the real world with a double line it's called a road and you're not allowed to cross it or get you get a ticket but it's not really that they want Revenue it's they're trying to protect you from getting head oned as you go around a turn on a windy road so the whole idea of double line is no fatal risks you don't cross the double line”
A broker told the speaker that his successful Treasury bond sale was profitable only because he had no experience; with experience, he would have second-guessed himself. The speaker now realizes this is correct because experience makes you 'ossified' in your thinking and less open to new information.
“I told him you know I sold it at like seven I sold on the top tick and he was I don't mean any you know I don't mean to be insulting but that's cuz you have no experience and I now know that he's right because experience can can make you aifi in your thinking right you're not you're not open or you're you from experience you you second guess things”
Interest rates rose from sub-1% in 2022 to over 5% in 2023, and some historical relationships that were profitable until 2021 are now 'completely backfiring'.
“in 2022 into 2023 interest rates went from sub 1% to over 5% mhm and it's it's interesting that some of the relationships that have been so helpful until 2021 are completely backfiring”
The speaker claims that he gave a speech 5 years ago where he was 'super bullish on 30-year Treasury bonds,' but did not own them in his portfolio despite the bullish view. When asked why, he explains: you cannot take fatal risks when managing other people's money; if you are 100% long a single bet, you can have high returns if right but are 'out of business' if wrong.
“a lot of people ask me hey I saw you at a speech and you said you were super bullish on 30-year treasury bonds you know five years ago how come you didn't own anything but that and I say you just simply don't understand a thing about investing you cannot take fatal risks and when you're managing other people's money you're going to have problems this one of the things I try to teach the young people begin with saying I know I'm going to be wrong from time to time that's where you start make sure it's not fatal”
The speaker has taken 'dramatic' protective measures to shield clients from potential 'crazy responses' to economic situations, and cites examples of policy rule-breaking over 20-25 years, including GM pension subordination, mortgage modification despite prospectus covenants, and illegal Fed corporate bond purchases.
“I've actually done some pretty dramatic things to protect my clients from what I fear could be one of these uh crazy uh responses to a situation we've seen a lot of crazy responses in the last I would say 20 20 years years 25 years maybe one of the first ones was in the early oos the Auto industry was heavily overleveraged they got into trouble um Ford actually went bankrupt and GM was on the edge of bankruptcy”
The current tight corporate spreads (all-time lows) reflect the same dynamic as the early 1980s: investors didn't trust government (Reagan's policy), so IBM corporate bonds yielded lower than Treasuries because people feared government debt more than corporate debt.
“I think that this idea that I have that maybe you can't trust the government with their debt management I think that that supports the idea that corporates should yield the least ever extra because when I started my career there were corporate bonds that traded at lower yields than treasury bonds because people were worried about what they thought was you know Reagan's ridiculous economic policy it was IBM for example IBM bonds offered lower yield than the same treasury bond and it was because people didn't trust the government”
If the government announces a 'Switcheroo' policy where all bonds with coupons higher than 1% would be capped at 1% (and lower coupons left unchanged), it would cut federal interest expense by 75% but would cause 30-50% overnight losses for bondholders. The speaker would profit from this because his bonds have ~1.5% coupons and would not be reduced.
“now if they announce well since we can't afford what's now our 4% interest expense on $40 trillion of bonds we're going to do a little Switcheroo we're going to say that if the interest rate that you your bond contractually pays is higher than one it's now one and if your interest rate you're paying is less than one it stays where it is well since the interest expense might be at 4% then if you take it down to just round numbers one you just cut the interest expense by 75% that's a beautiful way to Kick the Can down to the next Administration down to the next Congress down right because and everyone will cry you know bloody murder except me because I'll be sitting there saying wow we're heroes because there will be people that have 30 40 50% losses overnight if this happens”
The core skill of investing is figuring out how all the pieces fit together—how markets, institutions, and incentives interconnect. This way of thinking cannot be taught; people either are or are not interested in and capable of it.
“the whole thing about investing is is trying to figure out you you you think you understand this that how do this how does it all fit together how does it all fit together is something that is impossible to teach you you either you either are interested in that way of thinking and and capable of it or you're not interested in that in it or incapable of it”
The gap between the Fed Funds rate (5.38%) and the 10-year Treasury rate was the largest in the history of U.S. financial markets, suggesting the Fed is 'further behind the curve' and needs to catch up on rate cuts.
“the gap between the FED funds where it was at 5 and 38 and the tenure was the largest in the history of the US financial markets it had never been that the tenure was so low compared to the FED funds rate and by a huge magnitude ude”
The copper-gold ratio, which for 40 years was an excellent predictor of 10-year Treasury rates and stayed in near-perfect alignment, has become completely unreliable since end of 2021; the ratio now suggests 10-year rates should be below 1% while actual rates are around 4.75-5%.
“I invented something that is now somewhat famous in the industry the copper gold ratio take the price of copper and you divide it by the price of gold and for 40 years it was an excellent starting point on where should 10-year treasury rates be and it was almost identical all the time if you if you lined them up and anytime there would be a Divergence it was temporary and they they go back together again that that indicator is completely non-helpful ever since 2021 end of 2021 the tenear treasury rate is up at I don't know four and 3/4 or so let's just call it 5% and the copper gold ratio says that the 10 treasury rate should be below one”
The speaker has been in the investment business for over 40 years and claims to be right approximately 70% of the time and wrong 30% of the time. Over 40 years, this represents roughly 12 years of being wrong. The key to his success is that being right 70% of the time 'is a money machine' if the win-loss ratio is favorable.
“I've been in this business like I said over 40 years I'm wrong 30% of the time that's over 10 years of wrong it's actually over 12 years of wrong so I've been wrong a lot so my competitors always like to say gun Lock's wrong again I say yeah sure okay but I haven't been but I'm right 70% of the time and that's that's a money machine if you can keep that going and so the the the job is to try to keep that going”
From the Fed meeting before the July 31st 50 bps cut to the July 31st meeting itself, the 2-year Treasury fell 62 basis points while the Fed cut 50 bps. This means the Fed fell further behind the curve with its action, even as it was ostensibly easing.
“the FED uh cut rates by 50 but in the preceding meeting there was the well I'll say this from the meeting before where they did nothing to the 50 basis point cut the two-year treasury rate went uh down by 62 basis points they cut by 50 what that means is however far behind the curve they were July 31st they're further behind the curve now”
In the speaker's first year of work (early 1980s), interest rates were falling from 15% and he sold long-term Treasury bonds at what turned out to be the absolute top price (7%); four months later rates were at 10.43%. He was right on the timing purely because he had no experience and was not second-guessed by experience-based intuition.
“you know what the best trade I ever did in the business was very early in my career it was actually my first year and the the market was going up up up up up interest were going down from 15 they went down to seven and I was I thought it was kind of a Mania and I sold long-term treasury bonds I was I was I was amazing I I had I had like I'd been on the job six months I had almost no experience I sold them and as luck had it it turned out to be the absolute top tick it was the top tick nobody sold it a higher price and Se and uh four months later the the rates I sold them at 7% four months later they were at 10.43”
September 2024 saw the largest corporate bond issuance in American history, and the issue was oversubscribed (demand exceeded supply). However, this creates risk: when liquidity suddenly evaporates, investors cannot sell, so one must use moments of high liquidity to reduce exposure to illiquid or risky assets like Triple-C corporate bonds.
“September was the largest Bond issuance in American history largest corporate bond issuance in particular and yet they were it was over subscribed people wanted even more so there's tremendous liquidity but then there's moments where something goes wrong and you can't even get a bit so you need to use these moments of liquidity to be moving into more liquid more getting out of the liquid things into liquid things things and also pairing the stuff that has serious economic exposure risks like Triple C corporates and stuff like that which they're all incredibly expensive”
The speaker executed a Treasury bond swap, replacing longer-maturity 20-30 year bonds (coupon ~4.75%) with off-the-run 1-2 year bonds (coupon ~1.5%), maintaining maturity structure but shifting to lower coupons over a two-week period. This swap eliminated duration risk at 'negative cost' because off-the-run bonds offered higher yield due to lower liquidity.
“I said to myself what oh let me back up there's two non-controversial pillars of investing money the first is don't take a risk unless you get paid something for it pretty noncontroversial another one is if you can eliminate a risk at very little or no cost eliminate the risk so this all came to me I was actually in Toronto and where I'm going tomorrow and uh I was think think myself you know why don't we keep our maturity structure exactly the same in our treasury bond but swap the ones for say we buy have a 20- year we'll sell our 20 years and buy the one that has the lowest interest rate the lowest you know coupon as we call it and it took us about two weeks because we did it stealthily we didn't want this to get out because we would we would be trading against ourselves and within a couple of weeks we got our longer term bonds from a coupon of 4 and 3/4 that was a coupon of about one and a half”
When the 10-year Treasury was above 5%, the speaker predicted it would fall to the mid-3% range and was 'roundly criticized' for this prediction, but it turned out to be correct. This occurred because during economic weakness, investors bought bonds expecting rates to fall (historical pattern), causing rates to decline to the mid-3%.
“I predicted when the tenear treasury was above 5% that we go down into the mid- threes and I got roundly criticized for that but I was right but I thought that it would do that because when weakness started to materialize people would say oh I've seen this movie before economy gets weak rates fall so you make money on bonds and they would they and that happened”
The Federal Reserve is expected to cut interest rates several times by end of 2024. The speaker enters the conversation estimating one cut by year-end, but notes this has been one of the most volatile years for Fed expectations, with consensus ranging from 7 cuts at year start to nearly zero by end of March, then spiking to 10 cuts (250 basis points) before moderating.
“I I I think probably one at this point M um they're definitely dialing back this this has been one of the most volatile year for fed expectations that I've ever seen we entered this year with the consensus betting that the FED would cut rates 2 and a quarter perent 725 basis point Cuts during 2024 and then by the end of March there had been a scare of a little bit of inflation coming back”
The speaker is not in the inflation camp and expects inflation to be 'below 3% on the CPI at least until the middle of next year,' which should give the Fed further confidence to cut rates.
“a lot of people are worried that inflation isn't dead yet uh I'm I'm not really in that camp I I we've we've been pretty good on on the inflation forecast and we think we're going to be living in somewhere below 3% on the CPI at least until the middle of next year”
Two days before the July 31st Fed meeting in 2024, the speaker predicted the Fed would cut by 50 basis points, and this prediction was correct.
“and so I predicted uh two days before the FED last fed meeting I said they're going to cut by 50 and that was the but before the July 31st me they're going to cut by 50 and and they did”
The speaker is currently net short 20 and 30-year Treasury bonds and long 2, 3, and 5-year bonds on a leveraged basis (a pair trade). This position has performed well over recent months but not in recent weeks.
“I've I've in and out of being short long-term bonds and I I get the interest rate exposure by buying two three and five here and so I'm actually have have a pair trade so I'm actually actually short at the present moment 20 and 30 year treasury bonds and I'm long twos and threes on a leverage basis and this is this is not worked in the past few weeks but it's worked really well in the past few months”