ETF.com: Why is what happens to commodity prices—particularly oil—crucial to fixed income?
Gundlach: That’s been the case for decades. Oil is an incredibly important commodity. And oil correlates pretty highly to directions in interest rates. That’s because oil is a centerpiece-type commodity for inflation. Bonds care a lot about inflation. For government bonds, inflation is the most important thing. And oil is a harbinger of inflation. It’s not surprising that collapsing oil prices lead to a downgrade of inflation expectations, which leads to, on the margin, further support for bonds.
What’s been curious in the last month is that oil prices have been on a wild ride, and commodity prices generally have been on a wild ride. And yet for the month of August, the bond market was down in terms of total return, which is strange given the tremendous collapse that occurred in the commodity complex. If you’re going to take 20 percent out of the oil market price, under conventional wisdom, you’d’ve expected interest rates to fall substantially, not just 15 basis points or so, as we saw.
But again, go back to the Rosetta Stone. Why did this happen? Because oil collapsing meant the Fed was less likely to tighten. The more you analyze the markets, the more you realize the message has been crystal clear now, for nearly two years. The long bond wants the Fed to tighten. And I know that a lot of people have a hard time with that notion, but it’s difficult to look at the market data objectively and come to a different conclusion. People are far too committed to the idea that interest rates are about to explode higher. That’s been the wrong idea for years. And we’ve jumped to the wrong conclusion that the Fed tightening is somehow a disaster for long-term bonds. It’s exactly the opposite.