(Houston Chronicle) - When we last checked in with the Texas Bond King, he declared that Federal Reserve Chairman Jerome Powell was flat-out wrong about inflation being “transitory.” He predicted inflation would continue to soar, that central bank officials would have to raise interest rates much faster and higher than they were signaling, bond yields would rise sharply, and stocks could fall as much as 20 percent.
It seems so obvious now that it has all happened. But when Gilbert Garcia, managing partner of Houston’s Garcia Hamilton Associates, laid out this case in November, most other bond investors seemed the least bit concerned about inflation.
Seven months later, inflation has climbed to a 40-year high of 8.6 percent. Stocks have fallen about 20 percent, crossing into a bear market. The yield on the benchmark 10-year Treasury yield about doubled to more than 3 percent, before recently falling back below that threshold. (As a point of clarification, when bond yields rise, bond holders lose money. That’s because they are stuck with an investment paying a lower interest rate than what the present market offers.)
So now what?
Garcia says the Fed is already making its next big mistake by raising interest rates in huge increments, likely leading the U.S. into a steep recession. He says stocks may have further to fall as the economy loses steam and inflation remains sticky. He also predicts that bond yields may have hit their peak. He’s betting they’ll decline.
With about $18 billion in assets under management, Garcia runs the largest independent bond investment firm in Texas, giving him clear title to the nickname Texas Bond King. He recently offered his thoughts about what to expect next. This interview has been edited for length and clarity.
Q: When we last spoke, you said the Fed was making a huge mistake by not responding to inflation by raising interest rates and curbing its bond-buying activities. Why are you so concerned now that the central bank is doing just that?
A: They should have stopped buying bonds somewhere around September, and by January, it should have been clear to them that inflation was more than just transitory. They should have already raised rates. Now, they’re behind and they’re moving too far too fast.
Q: The Fed’s key interest rate was only 0.25 percent in November. Now it’s about 1.75 percent. Isn’t a bold move like that required to fight inflation? Should the Fed be raising rates even more?
A: There’s nothing to suggest that the Fed always has to raise rates by a quarter point or more with each move. It could have been a 0.10 percent or a 0.15 percent increase. The key was to just get started so they could glide to a higher rate. Now they feel so far behind they’re doing these big chunks of 0.75 percent at a time, and it really doesn’t give the market or the economy time to really absorb those type of shocks.
Q:They’re also removing the punch bowl - ending their aggressive bond buying program known as quantitative easing, which has been flooding the banking system with easy money for years and enabling the U.S government to issue trillions in debt. What will this shift to quantitative tightening do?
A: We don’t really know, but I think they’re underestimating what the quantitative tightening will do. They’re underestimating the size of the bond market, and the stock market, and the wealth destruction that can occur today versus how it may have affected the market 20 years ago.
Q: But doesn’t the Fed have to slow the economy to tame inflation?
A: I agree that you’ve got to slow the economy down to get inflation down. The problem is that they are now overreacting. And each step they are taking is just going to bring us into a much deeper recession and for longer.
Q: And you don’t like the Fed’s timing. Why?
A: They’re sharply raising rates as oil prices have gone up to some of the highest levels in history, and they’re doing it at the same time that consumer confidence is at the lowest in decades. Everything suggests that they are leading us into a recession.That will be the next mistake they make.
Q: The latest reading on the nation’s gross domestic product shows the economy shrank by 1.6 percent in the first quarter. If it shrinks again in the second quarter, it will have met the classic definition of a recession, two quarters of negative GDP. Might we already be in a recession?
A: Well, that’s right. And these natural forces are going to provide some relief to inflation, no matter what the Fed does.
Q: What other forces are pushing down the economy?
A: Money supply growth has plummeted. It takes about 10 months for this to affect economic activity. That means 10 months from now, the economy is going to be much slower than it is today. There’s going to be no more fiscal stimulus because we didn’t get the Build Back Better bill.
Q: What do you make of these two recent admissions: Powell conceding to Congress that a recession is indeed possible to fight inflation, and Treasury Secretary Janet Yellen, who preceded Powell as Fed chair, admitting she was wrong about inflation?
A: The Fed needs to be much more transparent. Why shouldn’t the Fed have all their meetings in public like governmental bodies. It would make the market a lot more efficient and we wouldn’t have these big swings.
Q: While you complain the Fed is moving too fast, Powell has indicated that there may be another 0.75 percent rare hike coming soon. Where do you think this will end?
A: The (benchmark) rate probably goes to 2.75 percent, and that’s a good place to be, but the Fed should get there over a longer period of time instead of slamming things.
Q: So what happens to bond yields and interest rates in your view?
A: We think from here rates have already peaked. By the end of the year, the Fed will be more concerned about a recession than inflation and it will have to stop raising rates. Unlike before where rates were way too low and people were complacent, now rates have risen very far, very fast. Now, we think that rates are going to be declining as the economy begins to lose momentum much faster than the Fed thinks.
Q: And stocks?
A. I don’t think stocks have seen the bottom yet. You could argue that stocks have reacted very fast, faster than normal, but I don’t think they will hit bottom until the recession is quite clear and apparent all around us. I think the market could end up down around 30 percent.
Q: Oil prices?
A: I expect them to hover around $100, but that’s far from the highs. Then I think they start going down to the $90s. People are already driving less and I would expect production to ramp up everywhere.
Q: And finally, what about the dreaded beast of inflation?
A: It will come down faster than the Fed thinks. It will be sticky, mind you. But the key is to stop the momentum.