Jeffrey Gundlach with Dave Rosenberg: The Hollow Tree

So you know um we were talking earlier the two of us and uh I had said that uh I don't remember uh really being this confused uh and in such a period of heightened uncertainty uh since I was at Mel back during the financial crisis and I'm not predicting that we're going to have a financial crisis but maybe you can't really rule it out either uh cuz nothing looks too stable right now and I'm of the view that when problems hit the Treasury market uh they don't stay confined in the Treasury market and I'm absolutely amazed and actually it was uh an article that showed up on the front page of the Wall Street Journal yesterday talking about how great the stock market's doing in light of uh what the bond market's doing without realizing uh that usually when the bond market has a yield meltup up. It usually has about a 3-month lag before it really hits the credit markets and the stock market hard. But even with that, and we were talking about this earlier as well, Jeffrey reminded me that um 75% uh of the S&P 1500 stocks are actually in a correction right now. Uh so when you look at the capweight indices, you get this view, everything's all hunky dory, but the average stock and the median stock is actually in a down between 10 and 15% from the 52- week highs. In any event, um, none of you came here to listen to me because you get to hear from me daily anyways, at least most of you. Uh, so I'm going to turn it over to Jeffrey, who's going, it's going to be Jeffrey Unplugged, uh, and talk about, uh, you know, this mess in the bond market, what you think brought us here, what's going to bring us out if we ever get out of it, what the broad implications are, uh, maybe get into the Fed. But without further ado, I'm going to hand it over to you and Jeffrey. Uh, we'd love to hear >> all right >> about your thoughts. >> I came up with an analogy last night. I don't know where it came from, but I've got a house in Buffalo. That's why it's easy for me to come up here just for a day type of a trip. And my uh my house in Buffalo, there's a silver maple tree. And the house was built in 1911. So, the silver maple tree is over a hundred years old. And I loved looking at the silver maple tree. It looked very healthy, had a lot of leaves on it, provide a lot of great shade, and yet it was old. And so I would worry about every time I'd listen to the buffalo weather in the winter time, I'd get nervous when there was an ice storm with high winds coming because I was afraid the tree might, you know, fail. And so I was thinking about this and uh a year ago, not even a full year ago, I get a call from my brother who lives in Buffalo and he says this humongous limb fell off the silver maple tree and he took a picture of it and it was truly humongous. The the uh diameter of the part that that broke off was like like my shoulders. That's how big it was. and it almost hit the chimney, but it was about a 100 foot branch. And uh the good news, the good luck was we didn't really have much damage. So I said to him, "Well, we better like trim up the tree. You know, we've got to take care of this." And he goes, "No, no, we have to take the tree all the way down." And I said, "Why?" And he said, "It's completely hollow." So I was thinking it by all appearances it was in decent shape. last summer, a year ago this summer, but it wasn't in good shape. It was on the edge of of complete failure. And I'm thank God that the branch fell down before the winter came so that we were because otherwise I don't know how we would have taken the tree down. But it occurred to me that that's where we are in the markets today. Rosie just talked about how the average the S&P 1500 looks decent on average, but when you go underneath the surface, you find there's many many you said 75% are in a correction or or worse. Well, I saw a statistic today that when it gets to the S&P 500, which is very close to its all-time high, 440 of the stocks in the S&P 500 are down more than 21% from their high, which is pretty remarkable. So, there's all this rot that's in the S&P 500, but it's not in plain sight. You've got to wait for the lip the branch to fall off to figure out that the market's hollow, just like the tree was hollow. And I feel like there's a direct parallel to all of this in the private markets. I also found it interesting in the news uh this week that Scott Bessant, the Secretary of the Treasury in the United States, went out and hired an old Wall Street uh guy to be a a a consultant or I can't remember what the word is, but some sort of an advisor on how to deal with higher interest rates and how to manage the buyback of long-term treasuries, which is starting to get into uh the area that I've been talking about for probably about three or four years now and that is that something has to happen with this interest expense problem. You know we have two we we have a trillion to a trillion for in interest expense. Every bond that's rolling off in maturities virtually except for the ones issued you know uh over a decade ago are being refinanced at higher interest rates. So the deficit is $2 trillion plus per2 trillion dollars plus per year and there's no attempt or even rhetoric about reigning that in. Besson says we're going to do it by growing our way out of it. Well the def the debt has been growing faster than GDP for decades particular if you take out if you know co really uh made it a really big dent in it but it's been happening for a long time. So you're not growing your way out of it. So something has to happen and I've been saying there are two candidates that I can think of in that something one is you print it which would be inflationary pretty pretty uh obviously and the other is and people react uh with disbelief when I say this they'll restructure it and one of the ways you restructure it is you buy the long-term treasuries so you're trying to cap the yields which hasn't really worked well historically and you finance it with short-term T bills. You you issue T bills to retire higher couponer term treasuries and in that way you can have the government structure. The Fed would have to be an accomplice with this that could then artificially lower T- billill rates with the Fed funds rate because they can control the T- bill rate with the Fed funds rate and in that way you could uh bring down the yields at the long end and manipulate the uh the issuance that would also be inflationary of course >> in operation twist 1961. So obviously that that is not likely to happen in the near term but this is where we are and I believe there's two reasons primarily three reasons I Rosie and I were talking about this so I'll add the third one the that yields are relentlessly rising one is the war problem with the diesel price and the price of Brent Brent crude oil which is always about to end you know this is always going to end next next week or you know we've We got a new proposal. We're talking again, but it never happens. So, that's one reason why rates are moving higher because inflation is headed higher as long as diesel is at these levels or going higher. The ne the next reason is there's a monumental amount of bond issuance. A monumental amount of bond issuance that's happening not just in the United States, all over the developed world. And now it's being joined by the AI. The the AI AI situation is out there. So we have the inflation rate, we've got the diesel, we've got the uh we got the war, and we've got this outrageous amount of bond issuance that is just going to keep compounding higher. And so the the path of least resistance at the long end has been up for a long time. I've been talking about this. and it will rise until such time as something is done about it. One something could be operation twist in size that would work temporarily. The next the other thing would be some sort of restructuring of the debt. Otherwise, you're just you're going to be uh choking on this interest expense problem. It's not not going to go away. So people know what's going on and nobody wants to uh to finance what's out of control freight train that's coming down the tracks with this interest expense problem. >> But that would that would represent uh a default. >> Yeah. >> And you got what like half of the treasury market is held by non-residents. So um they'd be unhappy. >> You have to treat all bond all treasury all treasury bond and note holders have to be they're per pasu. They have to be treated. >> They should they should be. >> Well, so basically that's a prescription for uh two things. Firstly, the the dollar will just plunge. >> Absolutely. and and so I'm on top of that dollar plunges um which is going to be horrible for the economy because import costs go up, you get inflation, real wages go down, margins get crimped and then uh I mean Xiinping will sit back very gladly because then we're going to pave the road towards in our lifetime China being the reserve currency and not the dollar. So you can't have the reserve you can't be the reserve currency and default on your debt. So, this is going to open up a a whole bunch a whole can of worms. Increases the cost of capital. Well, the thing is that they're going to think that we're going to take Treasury yields down. >> Um, but then the general level of risk in the markets is going to go up. So, the equity cost of capital goes up, the debt cost of capital in the private sector is going to go up. Uh, and we're gonna have like a just a horrible recession. So, I don't know. Like the thing is that Canada had I I think that there's some interesting things happening, right? Like we're seeing auction after auction starting to tail. Um, and for people in Canada that were around in the early 90s and I see Develin in the crowd, he knows what I'm talking about. This was happening in Canada's deficits got structural. the debts got structural and then all of a sudden one 10-year auction in Canada uh in uh 1994 almost failed. We almost did not fill that auction and the Canadian dollar plunged. Interest rates skyrocketed. We lost control of the entire yield curve and that so it was a crisis. So basically the way I see it is that we haven't had a crisis yet. Maybe what we're seeing right now happening in the treasury market, it's become unhinged. Uh I got to say, I've been in the business 40 years. This is uh and I've seen I've seen the bond market become unhinged before. This is the most unhinged that that I've seen it. Uh so this might be >> it's close to 94. >> It's the almost the catalyst. >> Well, and look what happened in ' 94. In '94, look what happened. Um Clinton lost the midterms in '94. Nuke Ingridge, Contract with America, and the next thing you know, by the end of the decade, we're running fiscal surpluses under under Clinton. Now, of course, it wasn't just Clinton. It was Clinton and a Republican Congress. >> It had to do with the demographics of the baby boomers in Social Security. That was a that was a demographic thing that happened because the boomers were were paying tremendously into Social Security and that was what caused the so-called surplus. There were there's liabilities against social security though. So it's a phony surplus. It wasn't really balanced. >> No, but you had under contract with America, you had a lot of spending restraint and then it was leftover from what got George um George HW Bush lost the election in '92 because he raised taxes. >> So that that mindset's going to have to change. But I want to I want to pivot towards um >> before you pivot, I want to say want to comment on what the what you opened up with and that is that Perry Poo thing. I just want to say a a a historical fact. Scott Bessant before he became Secretary of the Treasury, he floated the idea of doing exactly what I just said to foreigners. >> He actually floated that >> Maril the Marilago Accord. >> Yeah. Yeah. >> He actually floated that which >> you is probably like illegal as as you kind of frame it, but we do all kinds of illegal things. >> Well, they they haven't done it. Well, I I think that it would basically um end up being an unmititigated disaster cuz cuz cuz he's backed off and I and and I wrote about at the time like let's trace out what the >> laws of consequences are going to be for us. >> Even even if it were legal, you couldn't administer >> the dollar. Look, they'll just they'll just crush the dollar. I guess you'll say, well, you know, uh is a dollar decline any different than tariff increase going to protect domestic industry? Yeah. Um, >> but if you uh and then if we end the dollar as a reserve currency and and you know what, I'll I'll be the first to say I I never thought actually before now that I would say that I think in my lifetime we will see the US dollar no longer being the reserve currency. I never thought I would say that before. That's one of the reasons why I still like gold. I'm sure that people never saw what was going to happen in 1971 with gold convertability. So, um, but I'm I'm talking about like in the here and now. Like let's say that we had let's say that we had this um uh conversation in February. Um yeah, you know, so okay, the debt wasn't 40 trillion. That's a nice bunch of zeros. It was 39 something trillion. And we had rampant fiscal deficits for the past six years. That's on the hyperscalers were already going crazy with their spending and borrowing plans. This is in February. I'm not talking about February of 2022. This is February of this year. The 10-year note by the end of the month before the war was 3.97. >> Today, we're like we're like like 13 some odd basis points in short order. And a lot of that just happened in the past couple of months. Um so I don't I don't know if I buy into like the deficits, debts. Um it's because it was there. I'm not saying it doesn't matter, but it was there like a few months ago and all of a sudden people are fitting the narrative into the price action. Like what's changed? And this is what I want to ask you about. I'll tell you what I think. What's changed? Okay. And and and this is why I I I you David Zervos is going to be an adviser. Well, if they if they wanted to actually have rates not go up, they would have appointed Zervos to head up the Fed and not Kevin Worsh. because I think that US monetary policy is in this incredible state of confusion. Uh you you got this head of the Fed, he he he doesn't want to give guidance, doesn't want to say anything. He's telling the world, I follow the PC deflator. I follow headline inflation at a time when the only part of headline inflation that's a major problem is diesel fuel. So he's going to he's telling the world, I'm going to raise rates into a supply shock. Now what's fascinating to me I want to get your comment on this is why is it if it's if it is about inflation and he never talks about this right he never talks about this we got the consumer confidence survey today we got the umish last week consumer inflation expectations are not they're in a range they're not hitting a new high they're not hitting a new high uh they were a lot higher by the way on liberation day in April 2025 okay and nominal yields were a lot lower. Uh what is going on here? Mark tips break evens 5 year 10 year 5 year 5 year forwards 2.34%. Do you know that? But the Fed doesn't talk about this. He talks about diesel. But the bond market is telling him inflation is not the problem because you can actually strip out in the Treasury market the real yield and inflation expectations. And when I talk to my clients about this, I have to show them the chart of the break evens that they're the same level today that they were five years ago. They haven't moved. They're just in a range. It's been the real rate going up. And the real rate is like the real rate moves like the move index. People know what I mean about the move index. The move is the VIX in the bond market. It's had a massive heart attack. Guess when the heart attack started? The heart attack started when Morris took over the Fed in mid June. the 10ear note was not even 4.4% 4% then and we were thinking okay we've had an adjustment we got the war we got you know risk premia gone from 440 to like five and a quarter >> in a seven finger >> so I pin this on on on I pin this on on the Fed >> on Worsh what because really what's changed debt deficits that hasn't really changed right >> well I'll start at that worsh point I I think that absolutely it has something to do with Worsh I think Worsh reminds me of El Gore in the George Bush El Gore debate where there were three debates and a different El Gore showed up at each debate. The first one was the sighing El Gore. When Bush said something that Gore didn't like, he sighed very heavily into the mic. And that's all that anybody remembers in that debate is Elgore sighing El Gore. So they said, "No more no lose, lose the sighing." So, he shows up at the next one looking like a pumpkin. He's got on this incredibly loud orange makeup and you can't even process what he's saying because you can't get past this ridiculous look. And then they say, "You got to get rid of this look. No more signing. No more pumpkin." And then they they they he shows up at the third one and he shows up as Mr. Nice Guy. So, it's like who are you? Nobody knows who you are. That's why you lost the election. Worsh shows up at a press at one of his uh meetings, his press conference, and he sounds really hawkish and then he shows up at next one and he shows sounds really dovish and he shows up at the next one and you know he's he's got some other kind of spin to it. The the third one. The third one. Oh no. Then he goes does Jackson Hole was the third one. And he he starts out thinking it's funny to talk about hiking. He starts about talking about hiking. When I was here few years back, we went hiking and it was with this one athletic guy and it was really strenuous and was very steep and I went on one last year with this other guy and yeah, we went it was a hike but it was much more leisurely. So he's almost like saying I'm going to hike. So he's the Mr. No Forward Guidance. I don't know if it's not a coincidence that he starts out talking about hiking at at at Jackson Hole. It can't possibly be a coincidence. And so and then he ends he ends up hiking and then he has the last press conference and I write down shorthand notes question you know what the answer was question answer and I was writing it down at the most recent one and I would write down the question and I wrote next to it no answer. And I did that five or six questions in a row. no answer. There was no answer. And so I started said this guy is giving us on the thinnest grl possible on on this this this conference. So I I agree that Worsh has he's not really presented himself and we we're we're still learning about it. And one of the things that I've been thinking about why are yields going up when economic data comes in weak? It's because interest rates left to the market forces will go higher when the economy softens because it's going to increase the deficit. It will decrease tax receipts and increase unemployment benefits and the like. And I've been saying this since before the rate rise started happening. and the Fed cut interest rates what was it 175 basis points total from September of 2024 until January of this year every single maturity on the United States yield curve rose from over that time period that's never happened before in the past when the Fed cuts interest rates of course short-term rates go down but long-term interest rates ultimately go down as well every single single spot on the yield curve was higher uh after the 175 basis point cuts than it was before the first cut was made and not by a small amount all the way across the curve it's was about a 100 basis points that corroborates my idea that all the patterns from the past that we think have informed our ability to manage manage markets are informed by secular declining interest rates from 1980 broadly into 2020 that's not happening. >> I think I got a slightly different view. Uh so it would be the first time even in the 1970s we had three recessions. Okay. 1970 7375 7980 >> felt like one and but but bond yields went down during the recessions. Bond yields went down even though inflation stayed elevated and there's never been a recession where the fiscal deficit and government borings didn't go up because the automatic stabilizers kick in. Um, so the deficit always goes up. Why do bond yields go down? Is because risk appetite goes down. People shift from stocks to bonds and the banks call in their loans. People tend to forget that one of the biggest buyers of treasuries are the US commercial banks. And when you have a recession, they increase their liquidity ratio. So they cut back on their private sector lending and then they boost their holdings of uh bonds, MBS, so on and so forth. So this this is typically what happens. I'm not going to I I don't know so much about how things are going to change. I'm sort of focused on the Worsh Fed uh which I think is making a terrible policy mistake. So we should have had today's jolts number was bad. The consumer confidence number was bad. Treasury yields should have come down, but they're not because it's become 100% correlated to crack spreads and diesel. And that's because of Worsh. When Worsh tells everybody in this room that he's focused only, he's the first central banker to say he's not looking at core. Now, people always laugh at economists. Oh, you look at core X food and energy. So, you don't eat, Mr. Economist, and you don't drive. No, it's because those are you don't change your eating habits overnight and you don't change your driving habits overnight. Food and energy are special, okay? Because they're typically influenced by supply side events that are beyond the Fed's control. The Fed is should be concerned whether they're second round impacts. Even Vulkar waited for that. Vulkar inherited a mess. But at that point after Miller was replaced in the late 70s waited to see is the shock from energy feeding into core. Is it feeding into wages? Is it feeding into inflation expectations? So none of that's happening right now. But the Fed's raising rates anyways. So people are scared. People are scared to take on duration because why would you? They're the the Fed's paying you to just stay at the front end of the yield curve and clip 5%. The two-year notes almost at 5%. Why take what you're gonna get 30 basis points to go extend duration? It it so I think that this is actually about the Fed. I think it's about the Fed. So I don't think that the market if the market was so nervous about inflation that tips even would be gapping out. It's been the real rate. It's been the real rate. It's been the risk premium in bonds that's precipitated because we have not seen we have not seen Fed policy like this before. Worsh is certainly introduced a whole new regime and he's not talking very much. He has no dot plot. He has no forecast. He doesn't say anything. Um in any event, I do think that there's going to be something that's going to happen because all we talk about is government, government, government. But you know, you said before that part of the reason why things started to collide was you had the uh corporate sector dramatically raising its credit demands at the same time that we have these still stubbornly high fiscal deficits. Well, what if that stops? What if the corporate boring stops? What if basically, you know, we got this regulatory thing going on? We got this public backlash against data centers. the Democrats are not pro AI and they're going to win probably the House and the Senate it looks like in November the 3 and just what if look what's happening you know we talk about Treasury yields the average yield in the high yield markets 8%. We it's gone up more than the uh I mean spreads are gapping out 6% in the investment grade market. At what point does the interest rate in the corporate sector break the back of all this borrowing by the hyperscalers cuz then all of a sudden you might find they scale back their borrowings. That might be the genesis for bringing interest rates back down more reasonable levels. We all blame the government, all blame the government, government this. Meanwhile, three of the four hyperscalers are now basically um net cash flow negative, right? Net free cash flow negative, right? So they're running the same policy that the government is. They're running deficits on their balance sheet. >> I read an article today that said credit spreads remain incredibly calm. And I looked to the sub aspect of it. The Wall Street Journal it said investment grade. Well, it's true that investment grade is near. It's out a little bit but not a lot. But if you break it into two sectors, AI investment grade and investment grade excluding AI, you see to two totally different things. Investment grade excluding AI has not widened at all. AI investment grade over the past year has widened 75 basis points and that was as of a couple weeks ago. It's probably it's probably more than that now. Go to the high yield market. high yield market spreads are out a little bit on average, but again, if you do the non AI high yield bond market, it's pretty close to its tights. If you do the AI high yield bond market, it's out by over 150 basis points. And I bet you now, because this is a couple weeks ago, I bet you now it's out by 200. So that that's going out. So underneath the surface, it's it's the silver maple again. All looks fine on average. Tree looks healthy, but you start parsing it up and it's already starting to change uh in that market. I I I think that uh these these hyperscalers will go from massive borrowing to zero overnight. They'll keep going and it's going to go longer than most people think because they don't care if they pay 200 basis points more than 6 months ago. And then one day the music's going to stop and it's going to go to zero on that bar because nobody's going to lend to them. So I don't know that crossover point is going to be something uh challenging to navigate, shall we say. But in for for the time being they're not going to stop. They're they're going to do as much as they possibly can at today's interest rates. So I think the the supply issue is is very significant. Gold's going up. >> Is it central bank buying going? >> Yeah, certainly central bank buying is a part of it. Central banks used to have 70% of their reserves in gold. You know, they went down to 20 and I think it's up at around 30. I don't see any reason why it wouldn't go to 50. And I also think gold has become a legitimate asset class. You're no longer laughed at when you recommend gold. For for 20 years, you recommend gold. Oh, yeah. Yeah. Where where's your bunker? You know, where where you got your water and canned goods sword? You know, you're you're you're either a wildeyed speculator or you're a l lunatic survivalist. Now, you don't get laughed out of the room when you talk about gold. I've I've I've been I've owned gold since it was below $300. The most recent thing I did, which is over a year ago, a year ago, June, was to buy more. And if it goes uh anywhere close anywhere below 3,800, I'm going to I'm going to buy with both hands. I'm going to answer that with some investment advice because I I hear people on TV talking about they want to own TIPS to diversify their uh bond risk at the long end, particularly just over 30 years. 30-year TIPS and nominals are perfectly correlated. They the they go it's the same line. There's just that 2 and 12% difference between the two. If you think I'm worried about inflation, I'm worried about the long-end nominals. I'm gonna sleep at night because I'm going to buy long-end tips. You're making a huge mistake. A huge mistake. Because you're going to say, "Oh, here's my statement. I'm so glad I shifted from nominals to tips in the 30-year. Oh, look, the 30-year is down 15%." I wonder if I'm up on my tips. No, you're down 15%. They're exactly correlated. So, that's some investment advice, but I think I would want real rates to be higher than they are today to take the risk of buying 30-year bonds or 20-year bonds from the from the US government. I don't trust them. I don't trust them at all. So, I I I want real I want a real rate of at least 300 basis points. And I think the inflation rate, I don't care what the the two and a half thing that that's that's that's just a a residual of a calculation. I I think that the inflation rate is running, you know, you tell me what index you want to use. You got a grab bag to choose from, but it's running somewhere around 3 three and a half%. Some people say it's eight, but the numbers, I'm using official numbers, three and a half. So, I want a six handle on the 30-year Treasury for me to buy it. And I've been saying this for a long time. I I thought that the government shenanigans would start when we got the 30-year towards 6%. And we're not there yet, but we're getting close. We're we're at a 24 and a half year high on 30-year Treasury, and it's only at uh 5.62 or something. That's not a high rate. People that are talking about investment strategies for the last two years have been built on rates are going to come down and bail us all out. It's going to bail out my bad real estate investment in commercial real estate. It's going to bail out my private my overleveraged private credit fund. We enter 2026 with people saying we're going to be cutting rates in 2026. They talked about two or three rate cuts in 2026. In January, we're hiking. There are no rate cuts. I said in January after that Fed press conference, I said if your only reason to be bullish on risk assets is rate cuts in 2026, you're backing the wrong horse. There will be no rate cuts in 2026. So I I I think that this long rate problem is getting to the point where it's it's in all these other countries. The UK is even worse than the United States. Japan is probably worse than the United States. And that that's competition. when you have competition from other countries who many of which have bad bad problems, some are even worse than us like Japan uh and probably China is too, but there are others that aren't as bad. It doesn't matter. They're all they're all competing for all this borrowing and you've got the the the hyperscalers kicking in that are price insensitive. Well, I'm just going to say that you're 100% correct. Uh Worsh wants to get to 2% headline inflation. uh in the context of um an energy shock. So think about how crazy that is. He's going to destroy the economy. >> Have to. >> So basically, I'm going to come back to Ed De Look, I'll just say right now, if they're going to generate a recession, I'm going to buy bonds. I'm going to buy more bonds because I know what happens in a recession. Private sector credit demands go down. Good luck to the hyperscalers. As people start to see a recession, they're going to go long risk. They're going to cut back on the risk. It's going to be very difficult uh for these hyperscalers to finance because they haven't done that yet. We've not gone through a cycle of hyperscaler financing into a recession. Good luck with that because people pulled in their horns. Risk appetite goes down. Credit spreads widened out. And that's why treasuries even in the 1970s. But you're right. I guess Borch has given it to us on a silver platter. That's why the average and median stock are down 15%. Maybe we're building up towards a bare market in equities. We don't see it. We've had a cyclical bare market in treasuries that happened first. But I'm going to come back to the most important point in my opinion. It's not any of the stuff about 40 trillion a few months earlier 39 trillion. What is exactly what Jeff Gunlock said that we started the year um the dot plot had a rate rate cut. The market was priced for two rate cuts. What's changed? The hyperscalers have changed. I mean, at the margin, that story was already there. The deficits and deaths. We priced in a whole interest rate cycle. The one-year Treasury bill yields almost at 5%. Do you see what's happened here? We priced in a Fed tightening cycle not because of David Zervos, because of Kevin Morris. And there's they started to tighten last week, I think, >> but the yield curve at 20 basis points. Usually, it's 120 B. They're going to invert the yield curve. And here's what's going to happen. People are going to say, "Ah, the yield curve didn't work in 2022. It didn't work cuz there's $2 trillion of stimulus checks patting people's pockets, and that was an Energizer Bunny that kept on giving. There's no fiscal stimulus. And after November the 3rd, there's going to be completely fiscal gridlock. No fiscal shenanigans are going on anymore. We won't be talking about fiscal excess after November 3rd." That's the beautiful thing about gridlock happening after a midterm election when the party in power that screwed things up for the previous two years ends up not having one party power anymore. So basically Worsh if he's on a mission it's one thing to get I'm going to get to 2% inflation with a booming demand picture. There's no booming demand. It's a two-pronged economy. AI spending because X AI capex is negative year. the AI has sucked the vitality out of the rest of the business sector and then it's been basically uh the uh equity wealth effect on high-end spending on luxury goods and services outside of that there's been no growth in the US economy that the Fed is convincing everybody this is a robust their favorite words resilient solid and strong which is total it's total you can see right now they're talking about the payroll number from August you saw the jolts numbers today the jolts tells you the churning in the market. The labor market is not strong. But they have to say that because Trump will get even angrier to convincing the economy strong. We're going to raise rates. Yeah, he wants to get inflation down at 2%. I got news for you. When Vulkar left office, we we bowed down to Paul Vulker. Inflation wasn't 2%. More like four. And he didn't bring down the price level. The price level under Paul Vulkar went up 60%. In his uh in his seven years, he didn't bring down the price level. He brought the inflation right down. He left office at four and we're going apeshit over three. You're telling me inflation's 8%. I'm going to tell you if we took Well, if we took the rents, if we took rents in real time cuz there's distributive lags and we took home prices real times. New home prices are down 8% year-over-year. We're talking about inflation. New home prices. The builders are discounting prices to move product because their inventories are eight and a half months supply like it's nobody's business. And I hear about inflation, inflation, inflation because the oil price and the crack spreads are right on our Bloomberg terminal. Inflation's on the brain. What's going fertilizer, transportation, there's nothing bigger than shelter. And so, but he doesn't talk about that. War does not talk about that. I find I find the guy dangerous. Okay, my opinion. I never said that about any other central banker. Okay, this will not end well. And the bond market's priced that in because that's the reality. The cost of carry has gone up so much. The yield curve's flattened. It's been a bear flattener. We just priced in like what? Four more hikes. >> And 6 months ago, they're supposed to cut. And that's exactly going from one hike priced in, one cut priced in to a hike, and then four more priced in. Yes, that's worth under 25 basis points arithmetically across the yield curve. That's what's happened. It's I say this is about borch. It's not about to me not about anything else. But let's >> I'll just say one thing. You you said if a a recession starts to show up a little bit more convincingly on the horizon, you'd buy bonds and then you'd buy more bonds. >> On that first goound, I might buy bonds along with you. >> But you give me you won't stay long. >> You give me a call when you want to buy more cuz I I'll I'll I'll be happy to. >> You mentioned something interesting about mortgage back. >> I Okay. So, you're But you're buying Look, uh I'm I'm I'm not a pension. >> I'm not going to stay around long. I'm not an insurance company. I I don't have to buy it for 30 years. Okay. So, we're talking about we're talking about a trade, but the trade could last a year. Let me ask you mentioned something mortgage back securities before. That was very interesting. >> Yeah. >> Well, I was just talking about what's really the risk-free rate today. Is a 10-year Treasury a risk-free security? Maybe. But if you buy bundled mortgage back securities, residential mortgage back securities that were originated say six, five, six years ago or more, they're not going to default. Those homeowners have a large unrealized capital gain in that house. bought if bought a house for $100, had have had an $80 mortgage against it, the price of that home, broadly speaking, is up at least 50%. Over that time period, so the house is worth, say, 160, make it 60% up. The LTV on that mortgage is bel is greater than 200. They're not going to default. Rosie makes the point that well, you know, may maybe the housing market starts to crumble because you're under a certain economic circumstance. Sure, it could start dropping, but that's not going to eliminate all of your equity. It go from 200 to, I don't know, let's say it drops, let's say it drops by, you know, 30%. Goes from 200 to 140. It's still a huge it's still a huge uh cushion. So you can get out of that and they yield today about 140 basis points over treasuries. So you're talking about something that is giving you nearly 7%. And I think it's risk- free. Another risk-free asset which isn't quite as risk-free I think as the mortgage is but you take well-managed portfolios of the top top credit tier of the bank loan market which is AAA CLOS. They have tremendous subordination underneath them and you're getting sulfur plus about 130. What's wrong with that? You the Fed appears to be hiking rates. Sulfur is at 4% so you're getting 530. That's that's the 10-year Treasury yield and you have a floating rate asset. So that's what I think of as the risk-free. So I I recommend investors have dry powder in this environment. I say 20% minimum and I would I would have some of this stuff in that 20% because I don't think if you the CLLO's in particular there's no interest rate risk. You could also do it with other short duration high quality types of products. You get a yield of about 6% from a very solid sleep at night two-year or lower duration bond portfolio. And when you think about that, if the yield is six and the duration is two, that's a we have a thing called the Sherman ratio at Double Line where you take you take an asset perspective return and divide it by its risk and you want the highest ratio there possible. Well, in bonds, you have a proxy for future return. It's flawed. No matter it's the best one you have, yield to maturity. If you yield to maturity of six, we do know a very good measure of risk, interest rate risk anyway, in bonds. It's the duration. Duration's two. So you have a yield of six and a duration of two. That's a Sherman ratio of three. That means that for you to make zero, rates have to go up by 300 basis points. If rates go up by 100 basis points, you make 4%. What's wrong with that? That's T bills today. That's with rates going up. I have about 20% of a portfolio in this type of thing waiting for the stock market or the bond market to offer better opportunities duration and of course just the valuation of the equity market is is uh completely un it's completely untouchable. >> You also mentioned that you have uh emerging market local currency bonds as well in your >> I do I have that I have that in the the more intermediate bond portfolio. I have about 30% that I would recommend in bonds and I would barbell it. One would be in about the lowest risk intermediaration bond strategy there is. Happens to be one that I've run for decades. It owns no corporate bonds, no foreign bonds, nothing but US dollar-based and it's heavily invested in mortgage related and government securities. It's very uh very high credit risk and it's a little bit low lower duration. the other half of the bond portfolio I would do the most risky thing that you can do local currency emerging market bonds because I think you get yields that are seven depends you want that actively managed you don't want to have your your your emerging market uh portfolio local currency in an index fund where you've got all these basket cases these serial defaulters you want to avoid that type of stuff but get a yield of about 7% in that and I believe the currencies is going to work for you. If you're a a dollar, you Canadian dollar and US dollar are kind of tied together these days, but you you would probably make money on the currency translation. So, you invest in it taking the currency risk, which tremendously increases your risk, but this is why it's a barbell. It's the safest thing and one of the riskier things. >> Emerging Asia in particular, they they don't have a big fiscal problem. >> I uh forget China, but yeah, Southeast Asia. Yeah, emerging Asia. Absolutely. You know, I think you still got decent decent things out of areas in South America that don't include the serial defaulters and that's the only thing in the US bond market on a total return basis that's intermediate term. The only thing that's up now is local currency emerging market. I also noticed that GDP now from the Atlanta Fed for the third quarter uh it's very high. It's up at 5 something. Yeah. >> On a real basis. and it's up at 5 something a lot due to consumer spending and a lot due to inventory. That sounds like inflationary uh anticipation a little bit to me too. If you're a retailer and you think prices are going to go up, you want to build your re inventory now. Lock in the price and you'll be able to sell it higher down the road. If you're a consumer, maybe you want to buy that dishwasher now because maybe it's going to go higher. One thing that I remember from the 70s and early 80s was inflation expectations started to get wildly out of hand. I I remember the supermarkets were changing the prices on loaves of bread multiple times intraday. I remember going to the store and there's a loaf of bread and three prices on it, one on top of another. And I said, "Mom, why don't we just rip the first two off? But we're too we're too moralistic." So she said, "No, we we're not going to do that." But that that can start things going. And we're starting to see a little bit of that. There was a an economic report that came out and there was a Bloomberg piece written on it and said something about durable goods buying was better than expected in part due to people accelerating purchases trying to avoid future price hikes. Now how that reporter knows can mind readad why these consumers are doing it I don't know. they might be just, you know, using a sock puppet type type of thing. But it is interesting that just around the edges, you're starting to see a little bit of that uh showing up. >> The the the statistic that came out today that had the conference board thing of going down from what was it 89 to 82 or something like that, a big big drop. It also has a category that's inflation expectations for the next 12 months. they went up to 5.1%. >> The point I'm going to make that comes back to Richie's comment is there is no sustained inflation without the labor market playing ball. Uh so we could talk about people uh rationing motor fuel. Okay, that's one component of the CPI. Uh I said before that shelter is totally mismeasured and it's deflating. Rents are still deflating. uh I don't think people have a full understanding as to how much multif family units in the past several years were built based on a certain demographic projection and now population growth because of all the out migration because of Trump is zero. So we have deflation in rents and if you noticed it's only recently started to filter through into the CPI statistics. Now now maybe Wars will come because he wants to justify his soccer stance and say well I'm I'm going to take shelter out. So shelter is the biggest component of the CPI, not energy. And even you count on all the spillover impacts, shelter is the biggest impact. And shelter is actually deflating in real time. And that's going to show through over time. That's why I'm not that hawkish on inflation. But let me just say fundamentally there is no sustainable inflation without the labor market. I'm not seeing wage trends accelerate. You the best leading indicator of wages is the quits rate. What did what did voluntary quits do today in the jolts data? Quits are going down. People are losing confidence in the labor market and all the jokers at the Fed look at headline non-farm payrolls that are going to get revised six weeks to Sunday. The labor market isn't cracking but it's cooling. This is not 2022 2023 when the labor market was heating up dramatically. This is not the 1970s when everybody was unionized at a cola clause. Labor has no bargaining power. no bargaining power. So this quotes inflation that we're talking about this motor fuel is not real inflation. It's a tax because it's going to lead to because people do do you look at collective bargaining agreements cuz I do you look at wage settlement data where's the inflation? It hits the labor market you get negative real wages with a lag leads to negative real consumer spending. So that motor oil that you're spending more money on means you're not taking a vacation in Lake Tahoe next year. Now I think you're right Richie about wars is on some sort of agenda. But let's just be honest with each other depending on how much risk you have in your overall portfolio. If you believe in the new regime that we're talking about that Richie Pelosoft mentioned two there's a new regime he will detonate the economy to get to the 2% cuz this is not a demand inflation this is a supply shock and I'm going to tell you something about the Fed the history of central banks that tried to fight a supply shock with interest rate increases have never ended well and I don't think it'll end well for AI either okay because they're part of the economy they're not they don't have a zero correl relation to what's happening in the rest of the world. So I'm a I'm a little concerned. I think this is what's happened, right? And now you're seeing the stock market paying attention. Now your high yield spreads are starting now everything you see now we're seeing the domino effect and it always starts off in the Treasury market just like it did in 2007, right? Worsh is just amazingly mum about anything underneath the surface of just saying everything's fine in the labor market. He spends so little time talking about the labor market in those press conferences. He really, it's almost like employment is now a given. It's just going to be stable. It's in balance. It's all fine. We got this inflation problem. But actually, if you've kind of pushed the employment side of the dual mandate off off to the side of the table because you're basically saying that's taking care of itself, you still have a dual mandate. Unfortunately, it's forever going to be in tension. You've got an inflation mandate which he thinks calls for higher interest rates or at least the committee seems to think calls for higher interest rates. And then you've got this little thing that's been building the interest expense problem. These are will are forever 180 degrees incompatible with each other. You raise interest rates, you're going to raise the interest expense. So you're trying to fight inflation, you're staring right down the barrel of the interest expense problem. You want to cut interest rates. Well, now you're going to alleviate the interest as sense problem, but you're going to exacerbate the inflation problem. This is an impossible setup and it's going to have to break one way or the other. It's been that way for a long time. The only time that it wasn't correlated very strongly was CO. That's it. that that whole anomalous period it's it's really the same line. It's absolutely horizontal for the past five years and you go years before co it's exactly the same. I'll tell you I'll give you a little bit of of advice that's really incredible. I used to use nominal GDP 7-year moving average as a starting point for where the US 10ear Treasury should be. And it was data mind. Admitting it up front it was data minded but it worked. nominal GDP 7-year average was an uncanny predictor of where the 10ear should be and then rates overseas went negative and they didn't go negative in the United States or other places and there were something like 18 or 19 trillion dollars of native yielding bonds and this metric 7-year moving average of nominal GDP US stopped working very well so I thought about it and I said you know what we should somehow factor in this weird divergence in interest rates because, you know, interest rates are global. Sure, US interest rates have a lot to do with US economy, but it's also global. So, I I said, "What what if we use the 7-year moving average of uh nominal US GDP and average it with the German 10-year yield?" Sounds like random, right? Turns out that going back 40 years, that metric has a N3 R squared to the yield on the 10-year Treasury. N3. Nothing is 0 93. And if you if you actually did the past 30 years, it was actually a little looser in the 30 to 40 years ago. It's higher than that. It's the same line. It's It's just absolutely mind-blowing. I used it in my uh webcast this month called Gunlock Unlocked where I talk about things and you can take a look at it. It's a 0.93 R squared and uh right now that indicator says the 10-year Treasury should be at about 4.95 and it's about 5 and a quarter. So for the this moment in time, it's a divergence of 30 basis points, which isn't enormous, but it actually suggests that the tenure using this metric should be lower a little bit. It should be back where it was last week. >> Could we go to something that Bram Satov brought up was he mentioned Japan and is there anything on the yen carry trade or anything that has had an influence on the treasury market or global global markets? I find it >> I think I think it can I mean if we're trying to support the yen you know >> well it's interesting that Bess wants treasuries >> well you said before that the global bond market is all correlated with each other to varying extents and you got Besson wants Japan to raise rates >> and he wants the Fed to cut rates uh he wants the end to go up so the dollar goes down which if so facto you would say is inflationary so is is besson like discombobulated as much as worsh I think >> I want lower rates, but Japan, you raise rates. >> I think Bessant is more of a cardboard cutout than he is a a real creative policy or I I know he ran hedge fund money with Soros and all that, but that that's not like running that's not like running the Treasury Department. I don't think it's very relevant experience. And this thing with Zervos, I I think Zervos is good. I think Bessant wants to get out. I think I think he's trying to find an exit ramp as Secretary of the Treasury. I I think he he's found himself in a position that he is more difficult than he expected. I have a question for you about that. Well, is okay. Let's I'm just going to ask this question then we'll go over here and uh do you think November the 4th which is the treasury of funding announcement. Do you remember when Yelen in no early November of 2023 did that? Well, it's not Operation Twist. It was basically they dramatically reduced their issuance at the 10, 20s, 30s and flooded the system with bills. And between early November and the end of the year, we're down 100 basis points in the 10ear note. If you're long duration, you made your year in two months. >> Yeah. >> What do you think? It was November 4th. It's the day after the midterms. >> Would you do it before? Well, that's a day. Well, I don't know. Yeah, Yellen could have done it before, too. But you remember people always wondered why did Treasury yields peak in like late October of 2023. What was the magic? Was it wasn't it wasn't a non-farm payroll report. It was on the Treasury funding announcement because they they don't influence the demand. >> Yeah. >> That's the Fed. That's why this whole thing about buybacks, but they influence the supply, right? >> Yeah. But across the Why Why wouldn't you Why? It's kind of like draining the strategic petroleum reserve. Biden did it. Trump's been doing it. They're doing it so that they're trying to manipulate the price of oil down for the election. Why wouldn't you get rates down before the election with Operation Twist? >> Well, I got to say that be it'll be because you don't have the Fed on board. You see, because by the time that Yellen did that in October 2023, the Fed was done tightening, right? >> Yeah. It's not the first time that they've done that. >> What they really need for Operation Twist is they need the Fed to cut rates. >> Well, they need the Fed Well, the Operation Twist, they need what what they need is the Fed to do buying at the long end. Yes. >> And they the Treasuryy's got to do cutting of issuance at the long end. Yes. >> But the Fed's not this this the war is not uh you know, >> if you're piling up Ta bills, you're going to want T- billill rate down. >> Yeah. Well, you either want that would be helpful and and the other part Well, the other part is what the Fed's going to be doing with this balance sheet, but it's doing the opposite. Anyway, uh there's a question down here. >> Yeah, we have time for one more >> one more question. Five minute warning. >> Yep. >> Five minutes. >> So, uh Jeff, uh you want a mutual fund company um >> and other things. Yeah. >> Yeah. Yeah. Um, and I was listening to actually Paul Dud Jones and and he says the risks or some of the risks in the market are, you know, leveraged ETFs, uh, single stock ETFs. >> Um, >> Sure. It's it's it's that's all those are all the signposts of a mania. >> Yeah. And and so the other one I was interested in which is growing in popularity just because people are using it as a replacement to fixed income is like principal check and notes. Like you can't lose your money, protect the downside. How much of a risk is that? And last thing I'm >> who's who's who's guaranteeing this, an insurance company in the Barbados, you've got you got to look into if if you have an annuity or a a life insurance policy, you better check who's better check what's going on because you can eliminate all of that risk by transferring your insurance to mutual companies. It's these ones that are owned by private equity that own private credit that jam. This is a jamming situation. They're jamming their garbage debt into these insurance companies. It's exactly what happened. Pardon me. >> I'm just talking about the United States. I'm totally talking about the United States. Yeah. So, this is like the CDO business in 2005 2006 where companies were founded startups simply to be dumping grounds for for poor collateral cos. I know this. I know it very well because I was talking to the head people at Meil Lynch and these other huge issuers and they just couldn't take enough risk. And I said, "Why have we never done a deal with you for the past three years, Meil Lynch? You're the number one underwriter." He says, "We're never going to do a deal with you." I said, "Why?" He said, "Well, you you won't buy what we tell you to. We want startup companies. They'll buy everything we tell them to buy and they charge h less than half the fee that you charge." And I just said, "This is a total unmitigated disaster." And I went and talked to the number one guy at Meil Lynch who had told me he wanted to double his balance sheet usage to get more and more and more leverage. And I said, "You have a ticking time bomb here. Your your staff here is issuing all kinds of unworthy debt, jamming into places that they don't know what they're doing." And I was eating at a sushi restaurant with a guy and he was Korean and he wasn't even interested in listening to me. And I was thinking, why can't I get a rise out of this guy? He's about to blow up Meiral Lynch. Well, I I found out 3 days later when he collected his $250 million bonus for the preceding year, resigned, and moved back to South Korea. That's the Wild West. And that's what's going on with this this US circular insurance company private credit thing. It's going to it's going to be a disaster. It's already begun. >> Well, let's uh finish off with something positive. You like gold. >> I like gold. >> Go ahead. >> I like gold. >> You like the those bank CLLOs. You like mortgage back securities. Uh you like >> I like local currency emerging market >> local currency emerging market bonds. >> Yeah. Yeah. And I don't like equities very much, but if you're going to do it in the US, I would do equal weighted, not cap weighted. >> And just remember that you heard about the Sherman ratio for the first time here. >> I actually came up with it, but I gave it to Sherman. >> Okay. Well, say hi to Well, anyway, uh we are um we're at the two-minute warning, but I've been told I have no timeouts. Uh so I got three words to say to you. >> At least we're not down to 13 seconds. >> Three words. Three three words which is go bills Oh, heat.