Fed out of line and should cut by 0.5%, says Gundlach

The US Federal Reserve is finally poised to cut interest rates on Wednesday but the question on everyone’s lips is: by how much?

Borrowing costs have been held at a two-decade high for more than a year on inflation worries and stronger-than-expected economic data and while many forecasters anticipate the Federal Open Market Committee will reduce rates by 25 basis points, others are predicting a bolder 50 bps move.

Speaking at Future Proof Festival today in Huntington Beach, California, renowned fixed income investor Jeffrey Gundlach, pictured, founder of DoubleLine Capital, said the Fed is “out of line” and will cut by 50 bps.

He is also pricing in nine cuts in the next 12 months and a 1.25% drop by the end of 2024 – 0.5% in September and December and 0.25% in November.

Given the Fed funds rate currently stands in the 5.25-5.5% range and inflation dropped to 2.5% in August, Gundlach said that even with a 50 bps cut, the central bank is behind the curve. “I get criticized, even though I'm right about this; the Fed just follows the two-year Treasury, and the two-year Treasury is down at 3.6%,” he said. “So the Fed needs to cover 150 pretty quickly. I think they're going to start with 50.”

He added: “They're still too restrictive, no matter what they do tomorrow. They're not going to cut 75, although I'm starting to hear the lunatic fringe talk about it. I think you need further economic weakness to get to that type of [cut] – it almost sounds like an emergency at 75 but 50 is completely plausible and should be what happens tomorrow.”

The last thing the Fed wants, of course, is to cause more market volatility but Eric Golden, founder and CEO of Canopy Capital Group, said that balancing the impact of forward guidance and Main Street’s concerns over inflation and the economy leaves them in a tricky position when plotting the pace of cuts.

What marks this period out, Golden added, is how quickly consensus over the severity of cuts has lurched from one extreme to the other.

“[The Fed] don’t want the market to have a tantrum, but they also want to make sure that their mandate of focusing on inflation and unemployment are met,” he said. “My belief is that right now we're at a 60% chance of a 50 basis-point cut.

“It's moved dramatically. It's probably been one of the most volatile times in the short rate in a while and part of that is that the Fed wants to give forward guidance so it doesn't want to surprise the market. There are moments where if the Fed really wanted to impact the economy, the best thing would be a surprise but we're in a Federal Reserve regime since (former chair Ben] Bernanke, where we're talking about what we're doing and telegraphing.”

Golden said it ultimately comes down to how the Fed wants to be judged by history.

“If you do 25 and it's not enough, and the market pukes, then you think that you should have done more. Or do you start off with 50 and say let's give the market what it's kind of anticipating, see what happens and adjust in the following meetings.”