Back-to-School on the Markets with Jeffrey Gundlach (DoubleLine) & Solita Marcelli (UBS)
The desk interprets the recent commentary from Jeffrey Gundlach as a pivotal reflection of the macroeconomic landscape where rising bond yields signal escalating inflation and rate expectations. Per the full note , Gundlach notes that U.S. 10-year yields surged nearly 17 basis points to levels last seen in 2007, framing the event as part of a broader global trend where developed markets, excluding Switzerland, face similar upward rates pressure. This commentary coincides with our view that the sustained issuance of bonds, against a background of burgeoning budget deficits, will be a central theme influencing currency markets in the near term.
What the desk is arguing
The desk frames the commentary from Gundlach as indicative of a potential shift in market sentiment, particularly towards fixed income and its implications for currency valuations. Gundlach highlights a sharp increase in bond yields across the developed world, driven by bond issuance associated with rising budget deficits. This could lead to increased volatility in currency markets as investors recalibrate their expectations around interest rates.
Supporting evidence includes Gundlach's remark about the resistance of rates in Japan collapsing under the weight of the yen's weakness, a signal that global financial dynamics are shifting and that U.S. monetary policy may need to adapt in response. As the 5-year Treasury yield pushes above 5% for the first time since 2007, this recalibration will directly affect foreign exchange risk assessments.
The alternative read would involve dismissing these rises as mere fluctuations without broader implications. However, Gundlach's emphasis on fiscal deficits and supply dynamics suggests a more systemic issue at play, which traders cannot afford to overlook.
Where it sits in our coverage
Our consensus target for USD/EUR is 1.075, with a range of 1.04 to 1.12. Current targets from leading firms include: - jpmorgan: 1.10 (Mar-26) - bofa: 1.04 (Mar-26) - citi: 1.12 (Mar-26)
This view is aligned with jpmorgan, indicating a stable where we anticipate volatility rather than significant directional shifts, while bofa offers a more conservative outlook by targeting 1.04, suggesting divergence from wider sentiments.
How other firms see it
Multiple firms align with the desk's outlook emphasizing the bond yield dynamics, including jpmorgan and citi who are positioning for a strengthening dollar. Contrarily, bofa has taken a more cautious stance, suggesting a potential drop in the USD due to varying global economic pressures.
Monitor the USD/EUR pair closely, particularly in light of potential shifts in Federal Reserve policy and their ripple effects on currency stability. The interconnection with U.S. inflation rates through the PCE index will also be critical as we analyze currency movements going forward.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Gundlach indicates a systemic shift in rates is underway, shaping macroeconomic fundamentals.
- 02U.S. 10-year yields hitting a 2007 high indicates growing inflation expectations.
- 03Budget deficits and escalating bond issuance remain key themes affecting market sentiment.
- 04The current landscape sets the stage for heightened currency volatility as traders adapt.
Market implications
Investors should keep an eye on the rise above 3% in U.S. Treasury yields, as sustained levels may influence risk appetite across FX markets. The evolving fiscal landscape could lead to recalibrating of strategies ahead of anticipated Fed movements, particularly with inflation data impacting sentiment and positioning.
Risks to this view
Should central banks pivot unexpectedly toward a more dovish stance or if inflation data signifies a proven downtrend, these scenarios could invalidate the current bullish expectations on yields, leading to a return to previous lower rates and potentially stronger currency valuations.
Hi everyone. Dan Cassidy here. Welcome back to the UBS Market Moves podcast channel.
Today we are excited to feature the annual Back to School on the Markets conversation with Jeffrey Gundlach of DoubleLine Capital. Leading today's conversation from UBS is Salita Marcelli, Head of Investment Management. Salita, I'll pass it off to you.
Good morning, Dan. Thank you so much. Hello, everybody.
I'm very pleased to be here today with Jeffrey Gundlach, who is the founder, CEO, and CI of DoubleLine. I don't think Jeffrey needs much of an intro given he's been one of the most influential thought leaders in the industry for years now, especially within fixed income. So Jeffrey, thank you for joining.
I believe this conversation is particularly well-timed given the latest developments in rates, inflation, the Fed, and more. So let's drive right in. Let's start with the topic of the week.
The sharp move in rates yesterday, 10-year yields rose almost 17 basis points to the highest level since 2007. The 5-year pushed about 5% for the first time since 2007, and 30-year approached its 2004 high. While we receive new data like the strong PMIs, it feels like there's overall more uncertainty embedded in fixed income markets.
How would you characterize this latest move? Well, it's a global move to start with. We have rates rising all across the developed world, with the exception of Switzerland.
Rates are rising even in Japan. I think we're getting above 3%. People thought that the Japanese yield would never go up because it was being so carefully controlled, but the weakness in the yen led to some sort of a change in policy.
One of the things that's really driving all this is just the supply of bonds. There's this huge amount of issuance that's going on because the budget deficit just keeps growing, and there's no end in sight. Now we're going to build two more army bases in Greenland.
I don't know what they're going to cost, but I remember the base that we gave up in Afghanistan when we evacuated from there was something like $300 billion. We've got that happening, and then we've got all this AI and AI-adjacent issuance, which is either... I've seen different estimates for the coming several months, but it's like $900 billion or $1.4 trillion.
This is really putting pressure on investors' appetite. For the first time, we've started to see some initial signs. I wouldn't say they're terribly convincing, but there's initial signs of credit tiering.
In particular, if you look at the AI names and you compare them to everything in the corporate bond market other than AI, you see a very different complexion. In the investment-grade market, the non-AI investment-grade bonds are basically on their tight spreads. They're in the 70s over Treasuries, but the AI bonds over the past, I'd say it's been going on there for about eight months to a year, they've widened by about 60 basis points on the AI names.
That may or may not be a credit concern in terms of analyzing credit. I think it's more due to the fact that investors are skeptical of the ratings that are being assigned to some of these AI-adjacent bonds. Notice that when SpaceX came out and borrowed money, it kind of surprised people that right after the IPO, they borrowed like $85 billion or something, and they got a triple B minus rating, which as we all know is the lowest tier of investment grade.
As long as you have an investment-grade rating, you get preferable capital treatment by insurance companies. The market instantly rejected, almost instantly, that triple B minus rating, and the bonds are trading like a single B type of credit. And if we move over to the high-yield category, we've seen much wider widening out in the AI bonds.
If you look at the non-AI high-yield bonds, they're out a little bit, but not very much. They're kind of in the context of where they've been for the past year. But the AI bonds, they're out by 150 basis points as of last week.
I haven't gotten the most recent quote, I've been traveling. But 150 basis points, so they're trading like they're some far down to the junk category, not like the Oracle bonds, I think were rated double B or double B minus, and they're trading like a couple hundred basis points wider. That is more, I think, because these ratings are being challenged.
The ratings are coming from sort of non-traditional rating agencies, and some of them seem to be rating an awful lot of bonds relative to the size of their staff. And so I think the market knows that these ratings might be inflated, but beyond that, the market is assuming, I think accurately, that there's going to be a lot more issuance of these types of names. And that's in conjunction with the Treasury issuing.
I don't think it's a coincidence that Scott Besant signaled Operation Twist the very day after the national debt on the official debt clock crossed above $40 trillion. I was doing an interview with a podcaster earlier this year, and we're talking about $4 gasoline, and how that was a psychological level. And it sure seems out to have been right for the past six months or so.
When the price of gas goes below $4, people don't seem to be that concerned about it. But now I think it's up at about $4.40 on a national average. We're probably at $7 now in California.
I haven't been there in a couple of weeks, so it'll be interesting to see what the price level goes to. So, you know, this is a lot of consternation that's going on out there. The $4 level on gas turned out to be significant, and when I was talking about that six months ago on this podcast, I said, you know, $40 trillion on the national debt, which we're going to get to by the end of the year, it might turn out to be a psychological level, and it sure seems to be the case.
All of a sudden, it's very much in the news that we're over $40 trillion, and now we're at $41.1 trillion is where the debt ceiling is, and we're going to have to do something on the debt ceiling yet again, another fight over that, which doesn't do the markets any good. But here we are, you know, we're in this seasonal period. For some unknown reason, September and October seem to be seasonally weak, and this turned out to be a really bad September, but still a few trading days to go, but bond yields on the 10-year Treasury and the long bond are up by about 45 basis points in the last month, and so we've seen bond returns on sort of like the Bloomberg aggregate index go from pretty, you know, okay, kind of like zero types of returns or maybe negative a half or something now down to about negative three and a half on investment-grade bonds, which is really putting pressure, not surprisingly, on the valuations of equities.
The S&P 500, as of July 31st, the most recent number I have, had a CAPE ratio of 42.04, which is one of the highest of all time, and with rising interest rates, that CAPE ratio becomes more and more challenged to sustain. And if you look back historically, going back a long, long time period, if you look at 10-year returns after certain CAPE ratios, when you're up at this level, in fact, if you're above 35 on the CAPE ratio, you basically have never had a forward real rate of return from the S&P 500 that's positive. It's negative all the time, and there's several data points around this 42 area that we are on the CAPE ratio for the S&P, and those data points, the forward 10-year real rates of return for the S&P 500 after registering a 42 type of CAPE ratio have been something about negative six, and I think the best one is negative five.
So if Kevin Warsh is right, and he's going to get inflation down to 2%, that would mean that based on this long data series, which doesn't have to be prologue to the future, but there are no exceptions to this, and it's a lot of data, if we're in a 2% inflation rate and we get a negative six real rate of return, we're talking about a negative four return per annum for 10 years, which sounds pretty bad. So this is the environment we're in. At least bonds are not as ridiculously overvalued as they were five years ago, where we had huge negative real rates.
Now, at least the real rate with bond yields at five are positive, but historically, when you're in an environment where people are questioning the way the debt's being managed, like it was in the 80s and in the early 90s, investors typically wanted at least a 200 basis point real rate of return, and the inflation rate right now is kind of running at, there's a lot of different theories out there, but let's just say it's three to pick, I think, a number that's probably a little lower than the inflation rate really is. That would mean 5% on, say, the 10-year treasury. Well, that's where we are.
We're at 5.14. But if the inflation rate, if the deficit keeps going, keeps troubling people's ideas about financial market pricing, my viewpoint, I think I want at least 250 basis points or maybe even 300 basis points of real rate of return to be interested in, say, the 30-year treasury bond. And if the inflation rate is at three, that would mean a 6% 30-year treasury bond.
And that seems, you know, like if you'd said that to people a couple years ago, they would have thought that would never happen. But we are at 5.44, and it is the highest rate in essentially 20 years. And so the path of least resistance appears to be up, given particularly that the commodity complex continues to just boom.
The number one performing asset class year to date is, if you just use traditional indices, it's the Bloomberg Commodities Index. It's beaten all stock markets. It's beaten, you know, all U.S. bond sectors.
So, I mean, there's a real boom in the commodity market. That's great for commodity investors, not so great for gold owners, because gold is kind of stuck in the water after a huge rally last year into the first quarter of this year. But the price of oil just doesn't drop, and we're always looking for, you know, some magical things going to happen, and the war's going to end, and oil's going to go down, and maybe it will.
But we've depleted our strategic petroleum reserve in the United States by a very large amount, and we can't deplete it very much more, because you can't take all the oil out of the strategic reserve. The oil becomes corrupted once it gets down to a certain level. And so you're going to have to refill the strategic reserve, and it's not just the United States.
If we look at global oil reserves, they're at the lowest level in decades on just a number of barrels units. And compare that to the population, which has grown over decades, and the usage of petroleum, which with the population growth, has grown over the decades. And this is a very low level of reserves.
So while oil might drop, if there's good news on the war and so forth, I don't think it's going to drop down to 50 or 60. I think that the governments would want to start refilling that petroleum reserve. I don't know.
I don't know what the number is. I'm not a policymaker, but I would say probably it's 70. So it might drop, but it's not going to drop to pre-war levels, and we haven't seen the blast radius from these elevated oil prices really expand the way it will in the weeks and months ahead.
We've got the price of fertilizers likely to go up. We've seen shipping rates skyrocketing. I mean, some shipping corridors are up 400%.
So I don't see the real case for this 2%. I pointed out at the Fed press conference last week, the dots, the SEP, says the PCE is supposed to end this year at 3.7%. That's the committee's median guess.
And at the end of 2027, they're saying it's going to be at 2.3%. And that's a 1.4% decline. And I don't know what is the logic for that decline.
It's not just going to magically happen. Inflation's not just going to magically go down with the commodity prices complex where it is right now. So to get to 2.3%, I would think you'd have to hike.
And of course, now the bond market with this huge move in rates here in the month of September is gone from, I mean, in January, remember, the bond market was looking for two cuts in the Fed funds rate this year. And I said after the Fed press conference, I said, if that's what you're betting on, you're back in the wrong horse because there will be no rate cuts in 2026. And now, of course, we're looking at two rate cuts this year, rate hikes, I always say cuts, rate hikes this year in October, maybe, and in December.
And some people poo-poo the idea of October because it's close to the midterms. But I think that's just a ridiculous argument. And the popular, there's early voting, people are voting right now.
I know it might look bad politically, but I don't think that's a real election mover. So the Fed's probably going to raise rates a couple more times. And the two-year Treasury is at 4.9%, which sort of suggests that the Fed funds rate should be, you know, sort of at about 4.5%.
And it's only at 4% at the high rate of the band. So then I started, where should the 10-year Treasury yield be based upon some indicators that have been helpful over the past, when I say the past, I'm talking the past 40 years going back to 1986. It's weird how in the old days, we used to just use nominal U.S.
GDP as a starting point for where perhaps the 10-year Treasury yield should be. And right now, the 10-year Treasury yield is at 5.15%. GDP, nominal GDP right now, the seven-year average of it, which is what we use, nominal GDP is now 6.1%.
And this quarter's GDP looks like on a real basis is likely to be, you know, on GDP now, we're up at a five handle. So it seems like 6% is not unreasonable to think about for the U.S. 10-year. But a model we came up with back 10 years ago to factor in the idea that U.S. rates were positive when $19 trillion of other bond yields were manipulated to negative levels, we started to average U.S. nominal GDP with the German Bund 10-year.
And using that model, it says the 10-year Treasury should be at 5.9%, sorry, 4.9% right now. So under the GDP model, the 10-year looks a little elevated right now, but not by a lot, maybe by 25 basis points or so. But using nominal GDP might go up to 6%.
I would not be a buyer of long-term Treasuries unless the yield were about 6%, maybe even 6.5% on the 30-year Treasury. We've seen the yield curve flatten a lot now that the Fed has gotten more into a tightening mode. We've seen the curve flatten a lot.
The 230s was up at 130 basis points, and today it's at about 55. So that's flattened quite a lot, which makes the long end really even less attractive. So that's kind of my take on where we are.
We've been sort of feeling defensively about all markets since the end of July, middle of August, really, largely due to valuation. I talked about the CAPE ratio, largely due to before this move up in bond yields, it looked quite unattractive. And also, the seasonals are just bad, as I referenced earlier.
There's something weird about this September-October period. So it's not that surprising that we're seeing negative returns here in the month of September. So I'll just stop there and let you take this where you want to go.
Great. Thank you very much, Jeffrey. So maybe you touched on a lot of these things, but to tie it all together, can you maybe level set on where you see the best fixed income opportunities today?
So we already know your questions about the long end, and you like the short, but when you look at the entire fixed income universe, on the securitized credit side, emerging markets, where are the best opportunities from your perspective? Well, what I've done when it comes to the bond piece, I break the best allocation of four pieces, equities, regular fixed income, which means Bloomberg Ag-oriented type of thinking, and then real assets, and then finally dry powder. In stocks, really, all I'm really looking for is to get out of the epicenter of this overvaluation.
At this point, starting really two weeks ago, I really went to nothing in a market cap-weighted concept. In fact, the stocks that I recommend, I only recommend 30% stocks. That's pretty low.
And I recommend only one allocation, and that's to an equal-weighted index. So you can buy an equal-weighted S&P index. When it comes to fixed income, I have a bar-bill approach, which is kind of unusual.
It's an approach I started using, really, for the first time in my career, and certainly the first time at DoubleLine in the middle of last year, and that is to take something that has no corporate bonds in it. And what I think are the risk-free assets in fixed income are well-represented in these funds that I'm talking about. What's risk-free right now are mortgage-backed securities that are non-guaranteed that were issued five years ago or more, because the home price appreciation, while home prices are moderately falling now, the home price appreciation on the underlying mortgages under these pools that are five years or more old, they're up, like, at least 50%.
So if somebody bought a house at $100 and took out an $80 loan, well, the house is now worth about $150. So you have an LTV that's nearly 200%. So you're getting a spread on the good days.
It might be 130 basis points. When spreads are particularly tight, it might be 120 or so, 115. But I believe that's truly a risk-free spread above Treasuries.
So the Treasury bond market in sort of that five-year area is at 5%, so you can get up around 6.25%, 6.30%. And what I think is a risk-free asset. So that's one of our significant holdings there.
The other risk-free asset, which we don't own a lot of simply because it's really not good convexity so much, are AAA CLOs, which have been popular recently. Now that people are thinking about the Fed hiking rates, it's not surprising that they want floating rate assets that are at the top of the capital structure. So AAA CLOs, if they take losses, we're in really big trouble.
Not that that's a proper analysis, but I really don't think AAA CLOs are going to take any losses. They certainly didn't in the GFC. So you're getting there, you know, maybe it's 100 basis points or 110 basis points over so forth.
But again, these are significant spreads on, I think, the risk-free assets. And I do the exact opposite on the other half of my 30% recommended fixed income weighting, and that is local currency emerging market, which is, again, something I haven't done in a long time. Local currency emerging market has a double benefit.
It's actually the top-performing bond sector year-to-date in traditional sectors. It's not up very much. It was up about 4%, but with this route here in September, they're up about maybe 1, 1.5% local currency emerging market.
But you also have the benefit of, should the dollar decline, which is my base case of over the intermediate to long term, you're going to get a currency benefit, is half of the fixed income recommendation. The other half is about the riskiest thing you can do in fixed income, local currency emerging markets, because the volatility is amplified tremendously by the currency fluctuations. But the currency fluctuations have been on and off this year.
We're very positive early, then we're negative, and then we're positive. I think it's almost a push now. But at any rate, you've got a positive rate of return, and there's almost nothing in the bond market that's a positive rate of return.
Most things, as I said, are down 3.5%, some are down 4.5%. So you have to play defense there. And then I recommend some real asset investing, 20% of a portfolio.
I think 10% should just be in a commodity fund. And then I've increased, with the recent weakness in gold, I've increased my gold holding to 10% from 5. I was at 25% a year ago, but then dropped it down to 5, thinking it had run kind of hard.
But now with the decline, I think that's time to increase it perhaps for long term accumulation purposes. So that's 20% of the portfolio. And then the other 20, like I said, is dry powder.
And that means low risk, low duration funds. I'm not talking about things that are going to have credit risk. I'm not talking about triple C bank loans, which are a terrible performer this year.
I'm talking about things that are high credit quality, and just that just have a yield that's around 6% of a duration of around two. One thing we like to do at DoubleLine to start the risk management process, the starting point is what we call the Sherman Ratio. In bonds, the best proxy you have, however imperfect it may be, the best proxy you have for future return, which is the numerator of the Sharpe Ratio, is the yield, the yield of maturity.
So if you have a yield to maturity of 6 and you have a duration of 2, it's only a Sherman Ratio of 3. That means that you can have interest rates go up by 150 basis points and still have a return that's about the same as cash today, a return that would be about 3, 3.25%, even with that rate rise. By contrast, the Bloomberg Aggregate Index has a yield of about 5.3 or 5.4 today, and it has a duration roughly of 6.
So you have a Sherman Ratio there that is less than 1, which means that if interest rates rise by 100 basis points, even from here, even at these elevated rate levels, you're going to have a negative total rate of return for rates up 100 on the Bloomberg Ag. And so we're looking for things that will protect for higher rates. I've been steadfast in my statement going back six years.
I think 2020 was the secular bottom in rates. Now that they're up 500 basis points, that's not a controversial statement anymore. But I think the fundamental mistake people are making is from the experiences they've had, particularly for people who've been in the business maybe 20 or 25 years, they actually think that rates are high right now.
They feel like this is some really, I hear people talking about this great buying opportunity to get 5% on Treasuries. I mean, it's a lot better than 3, of course, and the inflation rate is not that too, but at least it's sort of stable. It won't really start dropping probably until the second quarter of next year when we have some high numbers rolling off on the year-over-year basis.
But 5% rate, it's just not that high. I think people have been jaded by the years, say the last, I don't know, I guess it was 20 years before 2020, where rates were at zero. And people think that rates were at zero where the long bond sub 2% is some sort of natural state of affairs, but it's not.
And I think that what's been perplexing and confounding investors when it comes to, say, private credit, private equity, they keep saying, well, when rates come down, we'll be able to exit. We'll be able to not keep doing these extensions and continuations. Our clients want their money back and we can't liquidate.
We've got trillions of dollars of trapped private companies and so forth. But the rates aren't going to come down like that. That was abnormal.
That was an abnormal condition. I think the interest rates at 5% are completely understandable based upon nominal GDP and the nominal GDP and German 10-year yield model. They're totally reasonable.
And GDP seems to be going up. And it might be going up on inventories, which makes me worry about inflation reigniting. Because when I was a kid, I remember that people, including my family, would start to feel like prices are heading higher and they would want to buy in advance.
And there's a good example of that last week. I mean, it's just one example, but it is interesting. Costco raised the price of their Kirkland brand motor oil last week by basically 100%.
They doubled it. And at the same time, they told their customers that they were rationing it. You only can buy so many, such a certain quantity of the motor oil every month or so.
And I think what Costco was figuring, and I think they're smart to do this, is that when you double the price of something, people will say, you know what, I keep hearing about the gas prices like $100, and they already doubled the motor oil. Maybe they'll double it again. And so people start to hoard.
They start to say, I'm going to buy in advance. I've noticed that there's been an increase in consumer spending in recent GDP now, revisions higher, and also in inventory building, which suggests also that perhaps consumers are buying early in anticipation of higher prices. And perhaps retailers are hoarding inventory, thinking, well, I'll buy it now, and maybe I'll be able to sell it at a higher price come the turn of the year or something like this.
So I'm not of the belief that, you know, people talk about how it's all real rates, inflation expectations haven't really changed. And certainly when you compare tips to nominals, you can draw that conclusion. But I don't really buy into that.
I think that the expectations that people have when you look at consumer sentiment indices, University of Michigan and the conference board and so forth, I think we're starting to see some movement higher on inflation expectations. So I think it's a time period where you've done well in equities this year, you've done very well in commodities, you haven't done anything good in bonds at all, except for maybe local currency emerging market. So you have to, I'm still playing, I'm still on the side that long rates are, path of least resistance is up until such time as operation twists kicks into high gear, which has not happened.
Six billion dollars of buybacks is like a day of the deficit. It's like nothing. But they can, I mean, they do have the wherewithal to control interest rates.
We saw that in the 1940s and mid 1950s United States. We saw it for decades in Japan. And then after all that work to try to keep their yields contained, they couldn't do it anymore.
And now they're joining the party of higher interest rates. So, yeah, I'm still conservative on credit. I'm still conservative on duration.
Thank you, Jeffrey. So, you know, you mentioned about emerging markets, local currency, but we talked a lot about deficit and higher rates. What what do today's fiscal deficit and higher rate environment mean for the U.S. dollar?
I think that I think the problem with the dollar is that when and if, I guess I should say not if, but when the United States goes into recession, I think the dollar is going to have severe weakness. I don't think it's going to be a flight to quality asset at all. I think we see that in the tremendous increase in the price of gold over the past four years or so.
The dollar, I think, is going to go down on deficit problems. You know, the deficit is already running at about two trillion dollars a year. This is going to be the highest.
We've got one more month to report, so this could change. But fiscal 2026, which ends at the end of this month, has the highest deficit percent of GDP in the last five years. And we have nominal GDP or real GDP on GDP now of around 5 percent for this quarter.
So, you know, we're running a deficit when the economy is supposedly on a nominal basis doing very well. And when that changes, there's going to be a very large increase in the deficit. We're at about 6 percent of GDP.
If you throw in all the wars and the natural disaster relief that isn't counted officially in the deficit, we're more like 7 percent of GDP. And we would very likely go to 12 percent of GDP should a recession come. Well, that would be an outrageous deficit, of course.
And it would be something like, you know, 3.6 trillion dollars or something like this. And that's more than half of today's tax receipts. So we're going to have to have some sort of action taken on this fiscal problem, particularly when the next recession comes.
We should be doing it now before a recession comes, but that's not the way politics works, unfortunately. So in the next in the next recession, I think the dollar will drop. I think the Dixie index, which has been remarkably, it almost looks manipulated.
I mean, it's heavily euro influenced, but it's basically the year to date. The low is around 98 and we're near the high today. I think it's around 101 and a half, but that's not even a 4 percent range on the dollar.
So when the Dixie starts to go down in the next recession, I think it'll drop by at least 20 percent. So the dollar will drop by a lot. And that would mean that local currency emerging would probably do well, but also just any kind of non-dollar investment and gold would probably do well and commodities broadly would probably do well.
So I just think that the biggest tell, I think, on my structural bearishness on the dollar was corroborated last year when the taper template came and we had the S&P 500 go into a correction. And it was the 13th correction defined as a decline of more than 10 percent. It was the 13th correction since around 2020.
And in the first 12 of those corrections, when the S&P dropped 10 percent or more, the dollar went up every single time. The dollar went up versus other currencies by around 8 to 10 percent on the Dixie index, all 12 of those times. But in the most recent correction, which was the paper tantrum back in 2025, the S&P dropped 18 percent or so and the dollar dropped by around 8 or 10 percent, the exact opposite of how the dollar typically behaved during risk off periods for assets like the S&P 500.
Well, that corroborated my idea that everything changed when we shifted from a regime of secular declining interest rates, which went on for 40 years, around 1980 to 2020, and suddenly entered a secularly rising interest rate environment, which is how I characterize where we are right now. I think it's telling that one of the longest time, most economically driven, kind of almost pedantic type of analysis was a man named Lacy Hunt at Van Huizington, and they turned bullish on treasury bonds to their credit when the yields were double digit, maybe even mid-double digit back 40, 35, 40 years ago. And they stayed bullish all the way through until earlier this year.
So they really overstayed their welcome. They were resoundingly bullish on treasuries in 2021, entering the huge bear market of 2022. They were still bullish all the way through that, but they turned bearish on bonds for the first time in decades in the first quarter or early second quarter here of 2026, which I think is really telling because he had developed a framework that he was using for 40 years, and it worked for 40 years or so, 35 or 40 years, and he continued to use that framework.
But as he continued to apply it to the post-2021 or certainly post-2020 bond market, it completely failed. And to his credit, once again, he decided that this framework isn't working anymore. The framework was useful and beneficial during a secular bull market, but we're now looking in the mirror.
It's no longer a secular bull market. It's a secular bear market. And this is the conclusion he came to.
You know, I mean, he's made some money on that bear call, but he would have made a lot more money to come up with back in 2020, 2021. So I think we are in backward land, and it's most important thing for people to consider is that, you know, the old rules will increasingly apply less and less. I mean, think about how good, what good friends we were with Canada are, like this big trading partner.
We had similar cultural ideas. We had not terribly different forms of government. We were all good friends.
When I was a kid, you could just go across the border. You didn't even show an ID. You just said, I'm going to, you know, Toronto, and no big deal.
You know, now they're talking about becoming an associate member of the EU. They're cozying up to China. They're declaring us something of an economic enemy.
What else do you need to see to know that the sands of the framework are changing? So all of these things are factoring in my thinking. So I think the straw that really breaks the back is when we go into a recession, and that deficit goes to three, perhaps $4 trillion.
I mean, so it's just some unthinkable number. You either have to print that money, which isn't helpful for interest rates or inflation, you know, so you know, or you have to restructure the debt. You have to drop coupons or extend materials or something that's extraordinarily radical and would be met with, you know, an outcry, understandably.
So this is what you should think about. I've pointed out, I think the Fed has a really big dilemma. You know, if they fight inflation and raise rates to fight inflation, then they're worsening the interest expense problem.
And that's a really big problem. You know, but if they don't raise interest rates, you know, then they have a problem too. Then they have an inflation problem.
So you have an inflation problem, but if you fight the inflation problem, you have a debt expense problem. So there's no, these are two bad choices. So perhaps the Fed wants to stay put because, I mean, at least they know where they're standing.
But that's the dilemma for the Fed. If you hike, it's a problem, and if you cut, it's a problem. I've been saying that the Fed always said they had two mandates.
It was full employment and a stable 2% of inflationary. I say they still have two mandates, but they clearly don't have employment as a mandate right now. Kevin Morse spends maybe one, maybe 5%, if 5% of his remarks about the employment rate.
All he says is employment's stable and strong and in balance, and there's no problem at all. So that's really not part of their mandate, in my view, at least that they're focusing on. I think their dual mandate now is the interest expense and the inflation rate.
Unfortunately, they will forever be at tension. It was one thing, you know, Jay Powell would say that the dual mandate of employment and inflation, they're compatible right now. And then as the year went by, his last year, they were more in tension.
He started talking about tension between the dual mandate, but then that settled down with the unemployment rate stopped rising and going back down to 4.1. But now the dual mandate is forever in tension because it's inflation and it's the interest expense, and you cannot deal with both of them simultaneously. You push on one, it's like a waterbed.
You push on one spot and it's just going to get a bump on the other spot. You're just pushing the problem around. So it's a difficult situation, but it's one of our own doing.
I've been railing against this deficit and this expense problem being ignored solidly for, I don't know, 20 years. And people ask me, well, what should we do? And I say, well, have Elon Musk invent a time machine.
We'll go back 20 years and we'll start being fiscally responsible. Of course, that's impossible. I'm being facetious.
But someone did ask me, what would you do if you were in charge? What would you do? And I would say, I would tell Congress, you must cut spending $1 trillion.
You must find a way that you have to cut spending $1 trillion by the end of fiscal 27. That's how I would start attacking this problem. It wouldn't be good economically, but our chance to do things that would be less harmful has passed, unfortunately.
So Jeffrey, you mentioned the impact of recession, but you don't expect one anytime soon, do you? Oh, I think when the AI sector retrenches, which I feel, I think we're past peak AI. I started to feel that way June, July, when it went from, it went from AI is the best thing in the history of the world.
We're all going to be able to retire and live on Tahiti in a life of luxury and the AI will do everything for us. And all of a sudden around June, it went to, except you're going to lose your job first. Your AI is going to kill jobs, but that wasn't enough to scare people.
So now we've got, starting a couple of weeks ago, we've got AI is going to kill us all perhaps by the end of this decade. Now that's a scare attack if I ever saw one. I think that's designed to create some sort of government intervention to try to build moats around the existing AI companies, but government intervention is not going to help.
So I think when AI, when the enthusiasm turns into AI skepticism, which I think is underway, we're going to see a really big drop in CapEx. I don't know when that's going to happen. I don't know if that's going to be, you know, in the next six months, next 18 months.
I don't know. Nobody knows, but it's going to happen. And when it does, there's going to be a huge retrenchment in the economy.
So the recession will probably come within, within the next couple of years, almost for sure. I don't think the AI situation is sustainable in any way under its current format. So, you know, our economy has been driven exclusively by CapEx.
I mean, that's what's driving the whole thing. And it's an enormous, unprecedented CapEx cycle. We've got earnings based upon this for the S&P 500 are up.
I don't even know what percentage is the forecast now for this year, 30, 36% or something. And then people are thinking that just extrapolating forward, that earnings growth is going to continue, not as high, but something abnormally high. And I would, I would say that idea in a big way, because these things, they all look, they all look unstoppable until all of a sudden something goes wrong.
And, you know, it's .com-esque. I mean, it's a very different dynamic than .com. At least some of these, some of these companies are making money, but a lot of them are, are bleeding money.
So there are some, there are some similarities there, but that was what would cause a recession. And when it does, like I said, there's going to be a very, very large, like, come to Jesus moment for the way we're running our government. All right.
Well, thank you so much, Jeffrey. You, you left us with a lot to chew on. It's always a pleasure to hear your insights.
And we've had a pretty impressive, you know, walkthrough of perspectives across many things, right up from rates to inflation and Fed and global markets and geopolitics, portfolio construction, equities. So really thank you, really appreciate it. And we hope to be back.
Thanks for having me again. I've enjoyed doing this. I feel like we've done it for a few years now and I'm really appreciate the partnership between our firms.
It's been very, very, very enjoyable and gratifying. So thanks for having me and everybody let's, let's go build two and O and I'm going the next three bills games in person. So pretty exciting.
So everybody have a great end of the year and good luck. Thank you for tuning in. Be sure to visit UBS.com slash studios to view the entire UBS studios suite of podcast channels, along with our video offerings, such as UBS trending.
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Transcribed by https://otter.ai
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