'I take that as a very bad sign': Billionaire bond king Jeffrey Gundlach explains how the Fed's inability to control the repo rate is masking deeper issues
- Jeffrey Gundlach, the CEO and chief investment officer of DoubleLine Capital, isn't buying the Federal Reserve's explanation of why rates spiked in the repo market.
- Gundlach thinks a lack of liquidity and demand is responsible for the rate spike - not the confluence of tax payments and mismatches between Treasury bill maturity and issuance, which has previously been identified as a cause.
- He says the repo market is "out of control" and a "problem."
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There's no denying that the Federal Reserve has been at the forefront of investor attention in 2019.
In the midst of a steep market decline - and after raising interest rates three times in 2018 - the Fed flipped their monetary-policy path 180 degrees and cut rates three times in 2019. Tranquility followed and higher markets ensued.
But then something strange happened. In mid-September, a sudden jump in rates within an integral portion of the financial system caused a panic.
"We stopped quantitative tightening early in the year, and we went to quantitative easing - maybe," said Jeffrey Gundlach, billionaire CEO and chief investment officer of DoubleLine Capital, on a recent webcast. "It depends how you want to frame what is going on with the Fed increasing its balance sheet - pumping more reserves - to try to deal with the out-of-control repo problem that started up September 17th."
The "repo problem" cited by Gundlach refers to the sudden rate spike in the market for repurchase agreements - an integral part of the US financial system where parties come together to exchange securities (mostly US Treasuries) for cash.
In response to the turmoil, the Fed injected stimulus into money markets to pull rates back down.
However, what was perceived as a one-time hiccup in markets has turned out to be more of a perpetual issue - and the Fed is still pumping cash into the system today, months after the initial quandary.
Below is a chart depicting the Federal Reserve's balance sheet from July of 2018 to December of 2019. Since the repo turmoil began, the Fed's balance sheet has increased by hundreds of billions.
"It's not unusual for it to spike at year-end," Gundlach said. "But it is unusual for it spike out-of-the-blue in the middle of September."
Below is a chart depicting spikes in the repo rate juxtaposed against the fed funds rate. In theory, both rates should mirror one another with little variance.
ICAP, Bloomberg, DoubleLineTo Gundlach, the rate action taking place in the repo market is alarming - and there must be an explanation for this sudden, unexpected increase.
"They blamed it on tax payments having to be made, causing a shortage of short-term money and also that there was a mismatch between maturing bills and bills that had to be issued," he said. "But what's strange about those explanations is that those facts were known before September 17th."
In other words, Gundlach isn't buying the Fed's reasoning behind the rate spike. Treasury bill issuance and maturity is widely known information on Wall Street. There's a calender depicting this. There must be some other reason for this dislocation within the market.
"It says to me that there isn't sufficient liquidity in the system and there isn't sufficient demand therefore to float overnight money 'repo' at anything close to the fed funds rate," he said. "It's sort of the market rejecting the interest rate levels that the Fed has set."
"I take that as a very bad sign," he concluded.
Read more on Fed repos:
The Fed's recent repo crisis was the fault of big banks and hedge funds, new study finds