DoubleLine CEO Gundlach: Fed to Favor Unemployment Relief Over Inflation Control Amidst Rising Economic Pressures

Jeffrey Gundlach, CEO of DoubleLine Capital, anticipates the Federal Reserve will ultimately prioritize combating rising unemployment over controlling persistent inflation, signaling a significant policy shift with broad market implications. This pivot is expected against a backdrop of increasing inflationary pressures from multiple sources and concerning signals emerging from key labor market and economic indicators.

Key Insights

Gundlach: Fed to Prioritize Unemployment Relief Over Inflation Control in Inevitable Showdown

Attribution: Jeffrey Gundlach

"At some point one of these dual mandates is going to win out over the other one. And I think... they will pick the... fighting the rise in unemployment more than fighting the rise in inflation."

Jeffrey Gundlach argues that the Federal Reserve's dual mandate—maximizing employment and maintaining stable prices—is facing escalating tension. While he foresees inflation moving higher, driven by base effects, energy prices, and tariffs, he also notes that certain long-term unemployment indicators are becoming increasingly worrisome. He believes the Fed is subtly preparing the market for the acceptance of higher inflation figures. Consequently, if unemployment begins to rise meaningfully, Gundlach predicts the Fed will be more inclined to cut interest rates, even if inflation remains stubbornly above their 2% target, perhaps lingering around 3% to 3.5%.

This anticipated policy direction suggests a crucial judgment call by the central bank, weighing the economic and social pain of higher unemployment against that of persistent inflation. For investors, this implies a Fed reaction function that may be more dovish than current consensus if labor market weakness materializes, potentially leading to a steeper yield curve as the Fed acts to lower short-term rates despite ongoing inflationary pressures. Close monitoring of employment data will be critical for anticipating this policy shift.

Multiple Headwinds Signal Inflation's Resurgence, Gundlach Warns

Attribution: Jeffrey Gundlach

"Jay Powell knows, just like everybody I think knows that there's upside risk to inflation numbers... the Fed knows the inflation rate is going to be probably worse at the next meeting and perhaps also at year end."

Gundlach identifies several key drivers pointing towards a resurgence or persistence of higher inflation. Firstly, unfavorable base effects are at play, as very low monthly CPI prints from the previous year (specifically a zero and a 0.1% reading) are set to roll off the annual calculation. These will likely be replaced by higher current monthly figures, mechanically pushing the year-over-year inflation rate up. Secondly, oil prices have experienced a significant uptick, rising over $10 a barrel (a 20% increase). Gundlach reminds investors that a sustained $10 increase in crude oil typically adds approximately 0.4 percentage points to the headline CPI.

Thirdly, the economic impact of tariffs introduces another layer of inflationary risk. Fed Chair Jerome Powell himself, as Gundlach notes, views tariffs as inflationary. While the precise magnitude is uncertain, they contribute to the upside risks for inflation. These combined factors lead Gundlach to believe that the Fed is aware that inflation figures are likely to be worse at upcoming meetings and potentially towards year-end. This outlook supports a cautious stance on assets vulnerable to inflation and underscores the value of inflation-hedging strategies.

Recession Watch: Key Unemployment Indicators Flashing Yellow

Attribution: Jeffrey Gundlach

"The indicator I think is the most valuable is the one year moving average of the twos tens yield curve. Because when it goes positive on a 12 month moving average basis, that's for the past 35 years that's been right at the front end of a recession and it is above now its 12 month moving average."

Gundlach highlights specific, historically reliable indicators that are signaling increasing risk of rising unemployment and a potential recession. He places particular emphasis on the 12-month moving average of the 2s10s Treasury yield curve spread. This indicator has recently turned positive, a development that, over the past 35 years, has consistently marked the "front end of a recession." Another critical signal comes from the U3 unemployment rate (currently cited at 4.2% in the discussion) relative to its 36-month (3-year) moving average. Gundlach notes this has already crossed above its 3-year moving average, another event historically associated with the onset of recessions going back to 1990.

While the acceleration in unemployment that typically follows this crossover hasn't materialized yet, Gundlach points to rising continuing jobless claims over the last two years as a leading indicator that foreshadows a potential increase in the headline U3 unemployment rate. If these trends persist, the Fed may be compelled to act decisively on its employment mandate, reinforcing Gundlach's thesis of prioritizing job growth over strict inflation control.

The Bond Market's Verdict: Anticipating Rate Cuts Amidst Inflationary Pressures

Attribution: Jeffrey Gundlach

"But in the bond market, what we've seen is a steepening yield curve. We've seen long rates going up substantially more than short term interest rates, which is the bond market's way in my view of taking sides and saying it looks to me like they're going to say we're going to cut rates even though inflation is probably higher than 3% between now and year end."

According to Gundlach, the behavior of the bond market offers a clear signal: it anticipates the Federal Reserve will ultimately pivot towards easing monetary policy, even if inflation remains elevated. The observed steepening of the yield curve, characterized by long-term interest rates rising more significantly than short-term rates, is interpreted by Gundlach as the market "taking sides." He believes this reflects an expectation that the Fed will cut its policy rate despite inflation potentially holding above 3% through the end of the year.

This market-based forecast is further supported by the Fed's own communications, which Gundlach notes contain "no talk whatsoever of a hike," implying that the central bank universally sees the next policy move as downwards. This dynamic reinforces his core thesis that when the tension between the Fed's dual mandates reaches a critical point, the imperative to support employment will likely override concerns about moderately higher inflation. This outlook suggests that while the Fed might lower short-term rates, long-term rates could face upward pressure from persistent inflation and substantial government deficits.

Dollar's Demise as Safe Haven: A New Regime for Currency Markets

Attribution: Jeffrey Gundlach

"when we get trouble, the dollar is not going to be a safe haven currency. The dollar will fall as we run into trouble... this is what I've been predicting is that the dollar will go down as you get into periods of fear and weakness in risk assets that certainly played out in March and April."

Gundlach presents a significant contrarian view on the U.S. dollar, arguing that its long-standing role as the ultimate safe-haven currency is eroding. He cites the market correction in March-April of the current year as key evidence: for the first time in 13 corrections over the past 15 years, the S&P 500 experienced a decline of over 10%, and contrary to historical precedent, the dollar also weakened. Gundlach believes this is not an isolated incident but rather a harbinger of a "different regime" where the dollar will depreciate during periods of market fear and risk asset weakness.

This shift is partly attributed to factors such as U.S. trade policies ("tariff rattling") and a potential reversal of massive foreign investment flows into U.S. financial markets, which he quantifies as having grown from $3 trillion to $28 trillion over approximately 18 years. For investors, this outlook implies a need to rethink traditional currency hedging and asset allocation. Gundlach explicitly advises dollar-based investors to diversify internationally, recommending an allocation of 10-20% of their equity portfolio into local currency emerging market funds and also favoring markets like Europe, India, and Mexico.

Long Bonds: Strategic Avoidance Now, Potential "Monster Rally" Later

Attribution: Jeffrey Gundlach

"There might come a time where they decide that they announce that they're doing quantitative easing... and if you do, then suddenly you're going to have a monster rally in long term treasury bonds... you might see a 15 point increase in the prices of long term treasury bonds in like two days or a week."

Gundlach currently advises a cautious approach, avoiding long-term Treasury bonds. This stance is due to the upward pressure on long-term rates stemming from persistent U.S. budget deficits (with national debt approaching $37 trillion) and a global environment of rising sovereign yields. However, he outlines a compelling, forward-looking scenario where this could dramatically change. As older, low-coupon Treasury debt matures and is refinanced at significantly higher rates (the average interest rate on Treasury debt is heading towards 4%, up from around 1.8% pre-2020), the escalating interest expense could become "very uncomfortable" for the government.

This fiscal pressure might eventually compel the Treasury or the Fed to implement a program to control or cap long-term interest rates, possibly through a targeted quantitative easing (QE) program aimed at bringing down mortgage rates and 30-year Treasury yields. Should such an announcement occur, Gundlach predicts a "monster rally" in long-term Treasury bonds, potentially leading to a 15-point price increase in a matter of days or a week. This creates a complex tactical challenge for investors: underweighting long duration now, but needing to be prepared for a rapid, policy-driven pivot.

Quotes

1. Jeffrey Gundlach on the Fed's Prioritization:

   "At some point one of these dual mandates is going to win out over the other one. And I think... they will pick the... fighting the rise in unemployment more than fighting the rise in inflation."

2. Jeffrey Gundlach on the New Market Regime:

   "We're in a different regime right now than we were from, you know, 1980 until 2020. That's at the core of my investment philosophy moving forward."

3. Jeffrey Gundlach on the Dollar's Future:

   "when we get trouble, the dollar is not going to be a safe haven currency. The dollar will fall as we run into trouble."

Market Implications

Jeffrey Gundlach's analysis points to several actionable considerations for investors navigating an increasingly complex macroeconomic landscape:

• Fixed Income Strategy: The Fed's anticipated leniency towards inflation while prioritizing employment suggests a steepening yield curve. Investors might consider favoring shorter-duration fixed income or the "belly" of the curve to mitigate risks from potentially rising long-term rates, while benefiting from any Fed cuts at the short end.
• Credit Market Vigilance: Gundlach highlights unusual behavior in lower-rated credit, such as Triple C bank loan spreads tightening despite rising defaults. This calls for a strategy of systematically upgrading credit quality within portfolios and avoiding the most vulnerable segments of the credit market.
• International Diversification & Currency: The potential shift in the U.S. dollar's role away from a primary safe haven necessitates a global investment approach. Gundlach recommends allocating a portion (e.g., 10-20%) of equity portfolios to non-U.S. markets, particularly in Europe, India, and Mexico, held in local currencies to capture potential dollar weakness.
• Long-Term Bond Positioning: While currently advising against long-duration Treasuries due to deficit and inflation pressures, investors should remain alert for policy signals indicating government intervention to cap yields. Such a development could trigger a rapid and substantial rally, requiring a swift tactical reallocation.
• Gold as a Strategic Holding: Amidst concerns about "profligate spending and borrowing in developed countries" and ongoing geopolitical uncertainties, Gundlach reiterates his positive outlook on gold, viewing it as a "storehouse of value." He maintains that gold could reach $4,000 an ounce, suggesting it remains a key portfolio diversifier and hedge.
• Anticipating Volatility: The confluence of inflationary pressures, tariff uncertainties, geopolitical tensions, and potential shifts in Fed policy suggests that current periods of low market volatility are unlikely to last. Investors should prepare for an increase in market volatility, particularly as we move towards the latter part of the year (e.g., "Labor Day type of period towards year end").