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Gundlach: Treasuries will Rally When QE2 Ends
By Robert Huebscher
April 19, 2011


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Slow growth ahead

The Federal Reserve, thanks to its quantitative easing policies, is now the largest purchaser of government debt, supplanting China for that distinction.  The latest round, a $600 billion bond-buying program dubbed QE2, is set to end on June 30.  “That is going to be a moment of truth for the US economy,” Gundlach said.

Without further monetary stimulus and with conservative fiscal policies like the $38.5 billion in budget cuts recently passed by Congress, Gundlach said the US economy will weaken substantially.

“If we are going to stop stimulating the economy to the tune of $1.65 trillion a year, it is blatantly obvious that the economy will suffer pretty dramatically if a true budget-cutting exercise were to take place,” Gundlach said.

Gundlach called the direction of proposed fiscal policies an “austerity program,” which by definition means lower economic growth.  “It's a little late to be starting that, because it is going to be really painful,” he said. “My view is that it is going to be so painful that it is going to be abandoned, and that is when the inflationists might be right.”

One likely outcome will be increased taxes on individuals, particularly wealthy ones.  Gundlach said that taxes would need to rise from 20% to 35% of GDP to solve federal debt problems.  He considers an increase of that magnitude likely, but he said that top marginal tax rates could increase to 60%.

The market reaction to prior quantitative easing events

Turning to Gundlach’s interest rate forecast, he said it is critical to review the market’s reaction to various monetary policies over the last several years, as shown in the graph of the 10-year Treasury bond below:

Impact of Quantitative Easing on US 10-year Treasury

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