Gundlach: Corporate Debt Blowup Will Unleash “Turmoil” In The Next Recession

Saturday, February 16, 2019
By Paul Martin

by Tyler Durden
Sat, 02/16/2019

Though he missed the torrid rebound in stocks during the first six weeks of 2019 (US stocks have, by at least one measure, experienced their best start to a year since 1991, when Gundlach didn’t expect the rebound to start until later in the year), Doubleline Capital founder Jeffrey Gundlach’s warnings about the risks endemic to the US corporate debt market (and the ballooning deficit) still resonate with thousands of investors, who are warily approaching the end of the business cycle with a mounting sense of paranoia. His warnings about how the deficit blowout has generated “artificial” growth are particularly poignant in light of the growing signs of an economic slowdown in Europe and China (though, as we pointed out yesterday, the PBOC appears to be doing everything in its power to change the narrative), as well as some weak indicators in the US (think retail sales and business sentiment).

And in an interview with Yahoo Finance, Gundlach once again expounded his view that, though the typical recessionary leading indicators are still only flashing “yellow-to-green”, and though the Fed’s promise to “pause” its QT program has soothed the equity markets worries – for now at least – there are still plenty of risks lurking beneath the surface.

And the most immediate of these, as Gundlach has previously explained (and as we have also pointed out in our own analysis), is the state of the corporate bond market, which, Gundlach believes, could tilt the next recession into a full-blown debt crisis. The corporate bond market has $700 billion in bonds maturing this year alone. What Gundlach is most worried about is the combined effect of this bonds rolling over alongside the Fed’s balance sheet runoff, which he said could lead to a flood of issuance, particularly in the long-end of the curve. As the next recession begins, we could see short term rates fall, but long term rates blow up, leading to a punishing steepening of the yield curve (leading to the type of “bear steepener” trade about which Nomura’s Charlie McElligott has also warned).

With the Fed’s QE exhausted, and the federal budget deficit already blown out to a staggering degree, Gundlach warned that policy makers will have little recourse. To illustrate just how precarious the corporate bond market risks have become, Gundlach cited research by Morgan Stanley which showed that after nearly a decade of rock-bottom interest rates, corporations have binged on debt to such a degree that, if one were to base their credit analysis solely on leverage ratios, then nearly half of the investment grade corporate bond market would be relegated to junk.

Heavily leveraged US corporates could endure mass downgrades, as investment-grade angels plummet from the sky, and just like that – the next debt crisis will have gone from contained to systemic.

Just like in 2006, the long-term, big picture risks could be the most consequential. All other short-term risks would be merely trivial details. “Like back in 2006, the only thing that mattered was you understood there was a credit crisis coming. I think this time the only thing that really matters is this problem with the corporate bond market and the national debt issue when the next recession comes.”

And when the next recession finally comes “there’s going to be a lot of turmoil.”

The Rest…HERE

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