Fed may expand balance sheet after repo moves

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The spike in overnight repurchase agreements may prompt the Federal Reserve to expand its balance sheet.

“Is it an imminent disaster? No. The Fed is going to use this warning sign to go back to some balance sheet expansion,” Jeffrey Gundlach, chief investment officer of DoubleLine Capital, said Tuesday during a webcast for his $54 billion DoubleLine Total Return Bond Fund. It’s a way of “baby stepping” to more quantitative easing, he added.

The Federal Reserve Open Markets Committee cut its benchmark rate 0.25% when it met Wednesday, the second reduction this year. In regards to balance sheet expansion, Chairman Jerome Powell said the Fed will revisit the question.

The Federal Reserve injected $75 billion into U.S. money markets Wednesday to quell the surge in rates on one-day loans backed by Treasury bonds, known as repurchase agreements. That followed Tuesday’s $53 billion liquidity injection.

Bond market expectations more than economic need are driving the Fed’s move to reduce rates, Gundlach said Wednesday on CNBC.

“The Fed doesn’t need to cut interest rates,” he said. “I don’t see what the real urgency is.”

On the macroeconomic scene, Gundlach reiterated his view that chances of a U.S. recession are 75% before the November 2020 presidential election. Once a recession does come, Gundlach predicts that there will be an explosion in the national debt.

Gundlach also warned of the recession likelihood last week, citing signals including the August yield-curve inversion that has resteepened this month.

DoubleLine Total Return, which invests mostly in mortgage-backed securities, returned about 5.4% this year through Sept. 17, better than 72% of its Bloomberg peers. Its five-year annual average return is 3.4%, better than 82% of rivals.

Here are some other highlights from the webcast:

“It’s not a great idea to be betting on lower interest rates.” He added that investors have probably seen the low of the year in benchmark 10-year yields, which sank to a multiyear low of 1.42% earlier this month.

Gundlach put the chances of a U.S.-China trade deal before the 2020 U.S. presidential election at almost zero. He said China has no incentive to make a deal before the election.

Bad news for the U.S. dollar: the next big move for the currency is down, Gundlach said, adding that investors should be diversifying into other currencies and markets.

He’s also less positive on gold in the short-term. But for a permanent portfolio position, gold should be held, he said, adding that “now is the time to be looking for a better buying opportunity in gold.

If the Democratic primaries were held today, Gundlach said he thinks Elizabeth Warren would win the presidential nomination. “It’s not going to be Joe Biden.”

Bloomberg News
Interest rates MBS Secondary market Secondary bond market Capital markets Jeffrey Gundlach FOMC Federal Reserve