Slower growth in China and worries over central bank tapering is causing a mighty hurt in emerging economies. Developing country currencies have been dropping and emerging economy stock markets are having their worst early year performance since 2009. Tomorrow the Federal Reserve will begin a two day meeting and begin the sale of $111 billion of notes and floating rate debt. Given the skittishness internationally buying into the Treasury's sale might not be a bad move.
In November 2013 I interviewed DoubleLine Capital's brilliant bond manager Jeffrey Gundlach for a virtual conference we held for financial advisors. During our conversation Gundlach discussed the contarian view he had about interest rates. At the time, it was almost impossible to find an economist or market pundit who didn't think interest rates were heading up. Gundlach made a convincing argument about why there was a good possibility that long Treasury rates could actually fall further as prices "melt up."
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Treasuries, according to Gundlach, remain the best investment in the world for high quality collateral (a must for heavily regulated banks) and safety (a haven for nervous investors and central bankers.) With renewed turmoil in the emerging markets, including a plummeting Argentinian peso, global investors are running scared. The 10-year Treasury yield hit an eight-week low today of 2.7% down from just above 3% at the end of 2013. Had you been smart enough to buy an ETF like the iShares Barclays 20+ year Treasury Bond fund (TLT) you would be up 4% in the last month compared to a 2% decline in an investment in the SPDR Dow Jones Industrial Average ETF (DIA DIA).
Below you will find Gundlach's prescient comments regarding Treasury prices and interest rates. As for stocks, Gundlach was cautious because of the prevailing risk-on, "Don't fight the Quantitative Easing" complacency. Given the stock market's recent drubbing, Gundlach's instincts were again, spot on.
TLT data by YCharts
GUNDLACH: One of the consequences I think might be alarmingly contrarian for people is–one thing that seems clear is that, let's just talk about the Untied States, the Fed buying a trillion dollars worth of Treasury bonds and guaranteed mortgages per year when the budget deficit is now less than a trillion dollars on a twelve-month trailing trajectory basis, they're taking all the high-quality collateral or a great fraction of it out of the flow in the market. So there's less and less high-quality collateral. There aren't any more Triple A, or Double A even, corporate bonds, yet we have a financial regulatory system that seems to want to increase bank capital and increase balance sheet holdings of high-quality collaterals. These things are in opposite directions. You're encouraging the financial system to hold more high-quality collaterals at the same time you're taking it away.
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