Jeffrey Gundlach says Fed will hike funds rate next week to save credibility — but shouldn't

Jeffrey Gundlach speaking at the 2019 SOHN Conference in New York on May 6th, 2019.
Adam Jeffery | CNBC

DoubleLine Capital CEO Jeffrey Gundlach believes that the Federal Reserve will still pull the trigger on a small rate hike next week despite the ongoing chaos in the banking sector that prompted extraordinary rescue action from regulators.

"I just think that, at this point, the Fed is not going to go 50. I would say 25," Gundlach said on CNBC's "Closing Bell" Monday. To save the central bank's "credibility, they'll probably raise rates 25 basis points. I would think that that would be the last increase."

The collapses over the past several days of Silicon Valley Bank and Signature Bank — the second- and third-largest bank failures in U.S. history — made some investors believe the Fed would hold off on rate increases to ensure stability. However, Gundlach said the central bank would still keep up its inflation-fighting efforts that it has promised.

The Fed will raise rates another 25 bps in March, says DoubleLine's Jeffrey Gundlach
The Fed will raise rates another 25 bps in March, says DoubleLine's Jeffrey Gundlach

"This is really throwing a wrench in [Fed Chair] Jay Powell's game plan," Gundlach said. "I wouldn't do it myself. But what do you do in the context of all this messaging that has happened over the past six months, and then something happens that you think you've solved."

Traders assigned an 85% probability of a 0.25 percentage point interest rate increase when the Federal Open Market Committee meets March 21-22 in Washington, D.C., according to a CME Group estimate.

While Gundlach sees more tightening ahead, he doesn't necessarily think that's the correct response right now.

"I think that the inflationary policy is back in play with the Federal Reserve … putting money into the system through this lending program." Gundlach said.

Officials unveiled a plan Sunday to backstop depositors at both failed banks. The Treasury Department is providing up to $25 billion from its Exchange Stabilization Fund as a backstop for any potential losses from the funding program. The Fed said it will also provide loans up to one year for institutions affected by the bank failures.

The widely followed investor also warned that the rapid steepening of the Treasury yield curve after a sustained period of inversion is highly indicative of imminent recession.

"In all the past recessions going back for decades, the yield curve starts de-inverting a few months before the recession comes in," Los Angeles-based Gundlach said.