Gundlach Round Table: "Jay Powell Doesn't Understand What's Happening In Credit Markets"

DoubleLine Capital's Jeffrey Gundlach has already express his views on the Federal Reserve's retreat into manipulation of both the financial markets, and the media narrative, via the central bank's continuing "ad hoc" operations in the repo market. He also hasn't been shy with his warnings - at the risk of being labeled a chicken little - that stocks will get crushed during the next downturn, even as the rest of the market sees every pullback as a dip to buy, and every disappointing economic print as another reason to root for another rate cut.

And during the first-ever Doubleline "Round Table Prime" featuring a handful of guests. In keeping with the theme, the panel stared with a discussion of the current state of monetary policy, and the cognitive dissonance surrounding the Fed's repo operations, and Powell's unwillingness to label it what it truly is: QE4.

As several of the panelists pointed out, here we are, already well into January, and the market is still grasping for the Fed's liquidity teat.

Which is why central banks will have no choice but to remain accomodative over the coming year, according to David Rosenberg of Rosenberg Research. Even referring to the Fed's rate cuts as a 'return' to loose monetary policy by the world's biggest central banks is misleading. The Bank of England is the only one of the world's main central banks aside from the Fed that managed to raise interest rates. And it's not like the Fed managed to get us that far off the zero bound before the potentially Trump-inspired about-face.

Rosie added that even though the economy is humming right now, the Fed's "rosy" economic outlook could be dashed by the weakness that's already beginning to show in the US consumer.

"When we look at what's going to happen in the coming year, I think all the central banks are going to remain extremely accommodative. My sense is that although the Fed would probably like to not have to ease policy and they're premising it on their rosy economic outlook, I think that rosy economic outlook is going to be challenged, and I think the biggest stress test is whether or not the US consumer - which was resilient last year - in the face of weakness in other parts of the economy, is going to remain resilient."

The economist, who for years was one of the most wide-read names (if not the most wide read) at Gluskin Sheff, added that rather than simply following in the path of Bernanke and Yellen, Powell has been, in his own way, quietly revolutionary.

For example, Powell understands the feedback mechanism between the corporate debt sector and the stock market (if companies can raise debt, how can they afford to buy back their own shares?)

"Jay Powell has completely broken with precedent. When credit markets seized up in late 2018, he's somebody who understands duration, he's somebody who understands the full credit spectrum. He grasps the magnitude of underlying assets not trading in exchange-traded bond funds - and that's kind of in the weeds. Jay Powell understood what was going on, and the feedback mechanism - how it could transmit back into the stock market via arrested share buybacks."

Instead of following through with the well-laid tightening path, long foretold in the central bank's dot plots, Powell has chosen to keep volatility contained "at any cost."

"He has chosen to break with his predecessor and try to get out in front of credit volatility, keep it contained at all costs, and obviously that's backed him into a corner because the only debate on Wall Street is how big the Fed's balance sheet is going to get."

But while Rosie expects rates to remain on hold in 2020, his fellow panelist, Danielle DiMartino Booth, an economic consultant who once worked at the Fed and is now one of its harshest critics, said rising geopolitical tensions could put rate cuts back on the table. 

Booth also pointed out that the Fed's repo operations are causing its balance sheet to rapidly expand. There's an expectation in the market that the central bank will surpass $4.5 trillion - its QE3 peak - "very quickly." The fact that the central bank is refusing to call this QE 4 isn't just ridiculous, it's suspect.

"And we’re at a record $100 billion a month run rate. Levels of quantitative easing that were unheard of and unseen when we had QE3 running in the background at $85 billion a month. This is the quietest rejection/denial that I’ve ever seen at this institution that I used to call home."

Right about here is where Gundlach finally jumps into the conversation, building on DiMartino Booth's point. Though the central bank likes to project the image that they're operating with a plan, in reality, they're just bouncing from one crisis of confidence to the next. Which is why Powell is trying to say "as little as possible," Gundlach said.

"I think Jay Powell has gotten into a mode where he wants to say as little as possible. When he started he seemed to have a framework in his head...particularly in the 4th quarter of 2018...but the market was by degrees and fairly consistently rejecting his framework."

And that's because it's not just about the stock market. Remember all those warnings Powell and other central bankers have given about corporate credit markets?

"If you remember in the fourth quarter of 2018, the high yield bond market was closed, it couldn’t float an issue for 2 months. And Jay Powell, As the stock market was down into full bear market territory, he got in front of the podium in December of 2018 and reiterated his multiple rate hikes quantitative tightening framework that the market had already rejected as a sound policy.

"And subsequent to that press conference, he struggled for six months to put back to back press conference messaging together that was at all consistent with the one prior. And it kind of shamed him into following the bond market."

"It seems to me that he’s just following the market at this point. And the market had been kind of leading the Fed...so I think what [Powell's] looking to do is hope things hang together and to get through 2020 and rates pretty much on hold the entire year."

Powell has also made some major blunders, Gundlach said, sounding almost as if President Trump really does have a justification for his disdain of the Fed chairman.

"Jay Powell did not understand in my opinion to what was happening in the credit market dynamic in 2018, and he also failed to foresee the dustup in the repo market in September 2019. I find that a little disconcerting."

"In retrospect, you can see there was pressure on the repo funding because there was a mismatch between the issued bills and maturing bills and the tax payments in early September...but both of those variables are completely known."

Mistakes were also made, in the panelists' estimation, when it came to choosing Fed personnel.

"The fact that Powell was a huge advocate for John Williams taking over at the New York Fed was mistake number one. Then there was the dismissal of the head of the New York Markets Desk. So you had the architect of quantitative easing leave in the middle of negotiations over the debt ceiling."

So far, the Fed has succeeded in keeping a lid on markets. But as Gundlach and his fellow panelists explained, Powell is walking a very tight rope. Something as simple as a slight unraveling of the American consumers' voracious appetite for goods and services might be enough to throw a wrench in the central banks' works, and expose the fact that they're - as many have pointed out before - already tapped out.

Watch the full interview below: