“The Fed had too heavy a footprint,” says DoubleLine’s Jeffrey Sherman


DoubleLine Deputy Director of Investments Jeffrey Sherman chats with Brian Sozzi of Yahoo Finance about recent bond market developments, 2022 return prospects, inflation, the Fed, and more.

Video transcript


JULIE HYMAN: We talked about our Brian Sozzi on mission. We are now ready to tell you where. He’s in Los Angeles at DoubleLine’s corporate headquarters for DoubleLine’s annual roundtable event. And Jeffrey Sherman is going to be focusing a bit more on stocks, as he’s also leading the energy for DoubleLine. Brian is with him right now. Brian.

BRIAN SOZZI: Hi, Julie. The best time of the morning for you. Jeff, good to see you again. I think the last time I saw you it was really from the neck. So it’s good to see you in person at your head office.

JEFFREY SHERMAN: Yeah. It’s great to be here. So thank you for joining us today.

BRIAN SOZZI: Sure. Before we started here, we were talking about the move within 10 years yesterday. This is the biggest one-day change in returns since 2009. What’s the message there?

JEFFREY SHERMAN: Well, I think you have to look at the whole curve as well because what we’ve had is you’ve had this juxtaposition of slower growth. But we are still growing. The economy is still growing, at least at this stage. This was therefore accompanied by a higher level of inflation. But that didn’t really translate into higher yields in the bond market. And so I know 10 years is the barometer. It sets prices for a lot of things like the housing market. It is also a barometer of the loans of American companies.

But, really, I think the biggest movement yesterday was about the long term bond, the 30 years. Why am I watching this? Well what we’ve seen is that long bonds really struggle once they drop below 2% to get past that number. And so yesterday was a critical date. In fact, we closed above 2% on long bonds for the first time in about six months and since we’ve seen this rally since the first quarter of last year. And so what we see there is one of those big pivotal moments.

Now, today, then we are waiting for the opening, and we see a follow-up. So to us, it really looks like this is the catalyst for the returns to really start moving. And potentially, it all coincides with the calendar reset. All of a sudden people are coming back. And I was a little worried about yesterday, thinking that maybe it was a little bit narrower market because, ultimately, the rest of the world was closed. We couldn’t have a vacation like the rest of the world. But you see the follow-up today.

And so I think this linking movement has some legs there. And, really, we have a feeling of inflation coming in about a week and a half. And it looks like last year’s inflation could have a number seven. And, I mean, you mean things that are long term records. I mean, we haven’t seen the CPI climb north of 7% or anything around 7% in 35 years. So there’s a lot of these big moves going on there. But, in reality, this is a reset of the overall price in the bond market.

BRIAN SOZZI: Will the bond market currently read that not only will inflation remain high, but we may in fact see an acceleration in the near term?

JEFFREY SHERMAN: Yeah. I don’t think the bond market per se gives you that. But certainly we see it. So in our forecast, we think inflation is probably going to be around 4% this year. So this is nothing like what the Federal Reserve is telling you at 2%.

BRIAN SOZZI: Certainly not transient, right?

JEFFREY SHERMAN: It is certainly not transient. And that’s why I think President Powell withdrew the word. We used to joke that it was like, I’m not sure that word means what you think it means.

BRIAN SOZZI: Well, transient means about four years, doesn’t it?

JEFFREY SHERMAN: I mean, listen, it’s all about the time horizon. It’s a [INAUDIBLE] love relationship. So really at the end of the day I think what you’re seeing here is that we’re going to continue to have high elements of inflation. What we do know is transient, is things like supply chain issues. Yes, we will be producing more semiconductors or chips this year. Yes, we are going to cover some of the ramifications of the auto industry. So things like that are transient. But what about wage growth? What about real estate prices, right, those things that haven’t fully translated into the inflationary component yet.

And so there’s going to be this transfer of some of these things that were indeed transient to things that are a little more structural in nature. So it’s hard to say, are we going to stay at that 4% level for the next few years? But I don’t think we’re going back to that old school of 1 and 1/2 to 2 percent inflation because it’s permeated the psyche for a while.

And so I think we’re going to have to deal with higher inflation levels. And the front end of the bond curve tells you if you look like the profitability spreads. Wobbly stuff. We say, how does the price inflation? But in the long run again, you know, you look at the 10-year break-even points, they’re like 2 and 1/2%. The bond market is therefore not convinced that inflation is here to stay. However, it is rated at a high level of inflation for the next two years.

BRIAN SOZZI: Yesterday I spoke to the other Jeff, Jeffrey Gundlach, at his place and I went through a, really, 25 or 30 paintings. And one graphic particularly struck me. This is when the Fed cuts its liquidity, the stock market at large is historically affected. Do you share this point of view? Is this a believable graph?

JEFFREY SHERMAN: Yeah no. It is absolutely believable. And we’ve all put that together to look at it. So we definitely believe in it. But, you know, the problem is, it’s liquidity. It’s that, you know, that pushes people off the risk spectrum. And what has also happened is that there has been distortions in the bond market because the Fed has had too heavy a footprint. They bought too many bonds. They’ve been there too long, which I think is the coincidental about-face President Powell did when he was reappointed. He spun around to say, well, you know …

BRIAN SOZZI: Funny how these things work, right?

JEFFREY SHERMAN: He is. And now we speed up the taper. And so I think what we need to see is what will happen over the next six to eight weeks as the Fed pulls out and pulls out. Can the market swallow the offer? The answer is yes in the short term. But if you think of things like the TIPS market, inflation-adjusted Treasury securities, if you look inward, the Fed has basically just wiped out any offers. The net supply of these assets has been negative for two years now due to the Fed’s footprint.

This therefore means that the market must again behave naturally. And so I think some of the awards you see here as well are from people realizing that reality. But, look, the market has price increases. Whether or not they’re going to metastasize this year and we’re going to come to fruition, we’ll have to see.

But the market has about three price hikes here. The market therefore listens to the president. He doesn’t listen to others. He listens to the president. And, at the end of the day, that says we’re going to have this really restrictive policy this year. We will get rid of the favorable and accommodating asset purchases. And they will start the hike. Whether they march or not or wait a few months, I don’t think they want to go too fast. But they’re not happy to see a reading of 6.8% on the latest CPI.

BRIAN SOZZI: And the last 30 seconds I have with you. I know you have to go to the trading floor and do your thing. But do you think we’re looking at a potential spring correction in equity markets because of what the Fed is about to do?

JEFFREY SHERMAN: Potentially, yes. I think there is a challenge here because we have a high valuation. This is the problem. It’s not just the Fed that is pulling out. It’s because it’s the only game in town. It’s not just stocks. It’s American stocks. Everything is now compared to US stocks. And people don’t even look at emerging markets. They don’t look at European stocks. Everything revolves around the American market.

And so I think there is a propensity for there to be a challenge there just because there is a high valuation. And so we have to either increase the income in it. We must have a healthy cycle. And the problem you are having right now is omicron. We have once again set records. So it’s a challenge. So there are also headwinds. But American businesses are also very healthy. There is therefore a possibility that this correction is simply due to some of the technical characteristics of the market.

BRIAN SOZZI: Very well. Well, time will tell. Jeff Sherman, good to see you. I’ll let you go, have a coffee, see the traders again. Happy to see you.


BRIAN SOZZI: Julie, back to you.

JULIE HYMAN: Sozz, thank you very much. And there’s going to be a lot more to come to DoubleLine from our own Brian Sozzi talking to the executives there.


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