Harley Bassman, The Convexity Maven

Harley Bassman · Simplify Asset Management

Treasury's long-bond buybacks are a short-term fix that makes it look weak without a plan.

Against a deficit of about $2T a year, the Treasury's buybacks of long bonds are trivial. The program only runs for a limited time, makes things worse, and makes the government look weak because there is no plan. He wants a legitimate plan, possibly involving a Fed-Treasury agreement, and expects the Fed to eventually bring front-end rates down.

“He's doing it for only a limited amount of time. It actually makes things worse. He looks weak because there's no plan.”at 13:01

Harley Bassman · Simplify Asset Management

Rate-insensitive hyperscaler bond issuance is pushing long-end Treasury yields higher.

The hyperscalers plan about $2T of new debt this year on top of roughly $4T of gross rollovers. Hyperscaler estimates for the five big companies come to about $750B, roughly a third of what the government borrows. They are rate-insensitive because they must spend to stay in the AI race and would issue at any price. Anyone buying a hyperscaler bond is not buying a Treasury, which pushes the whole complex higher in yield, especially 10-year and 30-year.

“any entity that buys a hyperscaler bond is not buying a treasury bond. So that pushes the entire complex up in rate.”at 17:34

Harley Bassman · Simplify Asset Management

Japanese investors will buy fewer Treasuries as the hedged USD-JPY rate spread has compressed.

When Japanese rates were near zero and US rates were 3% to 4%, Japanese life insurers and other investors bought structured products that exploited the spread. After hedging costs, that spread has compressed significantly, and the yen has been crushed, so that demand has faded. He expects less foreign buying of US dollar assets, though Japan won't sell outright; it will simply buy fewer.

“but they're gonna buy fewer because the spread between USD and JPY rates, after you include the hedging cost, has compressed significantly.”at 18:17

Harley Bassman · Simplify Asset Management

Long-end yield backup is a supply problem, not a shift in the buyer base.

Asked whether changes in the buyer base (Japan, China, the Fed) explain the softer back end, he says buyers haven't changed much, with foreigners perhaps a little different. The cause is supply from a fiscal situation out of control and hyperscaler issuance. He notes pensions and insurers, traditionally natural 30-year buyers, are now solvent and can buy long bonds, but they are running out of gas.

“It's just a supply issue. The buyers haven't changed all that much.”at 20:01

Harley Bassman · Simplify Asset Management

Real yields near 2.5% are crazy cheap, if CPI accurately measures inflation.

With 5-, 10- and 30-year TIPS real yields around 2.5% to 3%, he calls real rates crazy cheap. Lenders get a real return with almost no default risk because the US cannot default, and people need somewhere safe to store large sums. His view depends on CPI being a legitimate measure of the inflation investors will actually experience, which he doubts.

“Assuming that CPI is a legit measure of inflation that you're going to experience, which maybe it's not. But to the extent you can get a real rate of two and a half, I think that's a pretty fancy rate.”at 20:23

Harley Bassman · Simplify Asset Management

Two-year Treasuries at about 5% are a good trade with almost no duration risk.

Responding to the host's point that two-year Treasuries are the best trade, he says you can't complain about a bond that carries almost no duration risk. He notes the rate is state and local tax free, so holders keep the yield after those taxes. This is a brief endorsement rather than a detailed case.

“you can't cry about that. You have almost no duration risk. You're locking in a rate that's state and local tax free.”at 26:50

Harley Bassman · Simplify Asset Management

A 5% 10-year yield is just a return to normal; rates were abnormally low before.

Harley argues the 1-2% rates of the 2010s were the anomaly, enforced by central-bank buying and the Fed's thumb on the scale. Rates had been around 3% in normal times, and the current move to about 5% is simply a return to where they have always been. He adds that markets always overshoot, so the adjustment is not a blowout.

“A 5% tenure is basically where we've always been.”at 37:50

Harley Bassman · Simplify Asset Management

A MOVE index of 100 is normal, not elevated; it is back to the historical average.

Dean suggested a MOVE reading of 100 is elevated. Harley responds that 100 was the average for the 1990s and for a decade afterward, and it looks high only because the 2020s readings were unusually low. Readings of 60 and 130 are both mispriced relative to the old range, but 100 is simply the normal level.

“So being at 100 right now, it looks like it's up a lot, but it's not. It's just gone back to where it used to be, which was 100.”at 38:48

Harley Bassman · Simplify Asset Management

In an equity selloff, front-end yields fall sharply in a bull steepening; 2-year near 4.40%.

If unemployment rose to 5% and equities sold off 10-15%, Harley expects a bull steepening. Front-end yields would fall hard as investors move to bills and the Fed stops hiking, with the 2-year dropping by up to about 100bp. Long-end yields would fall less, so the curve steepens. He gives a rough 2-year level of 4.40% against a 4.90% current level and a fed funds rate near 3.90%.

“Front end goes down hard. Everyone moves to bills. Two years on him. They'll go down by a 100. So it's probably a bull steepening event.”at 48:22

Harley Bassman · Simplify Asset Management

Owning companies that can raise prices is among the best inflation hedges; stocks are not breaking.

Stocks have not broken even as rates rose about 150bp, because investors are holding stakes in businesses that make money and can raise prices, not government bonds or dollars. He cites a German company whose stock holders were fine through inflation because the company kept raising prices and expanding. He sees a flight from Western paper into other things, including stocks.

“It's stock in an entity that makes money and can raise prices with inflation. As a matter of fact, one of the best hedges against inflation is owning a stock that can raise their price and manage their business.”at 4:13

Harley Bassman · Simplify Asset Management

Higher long-term rates mechanically cut the present value of stocks' long-dated cash flows.

A stock is a stream of cash flows stretching fifty years, discounted to today. Moving long-term rates from 3% to 5% therefore reduces the present value of those flows, since small changes in the discount factor compound across decades. Harley therefore says rates do matter for stocks on valuation grounds. He qualifies this by saying equity value is effectively meaningless given passive flows, so the valuation channel competes with flow-driven pricing.

“on a valuation basis, if only because a stock is a series of cash flows out the next fifty years discounted back to a current present value. And so if you take long term rates from three to five, you will go and reduce the value of those cash flows in today's terms.”at 39:42

Harley Bassman · Simplify Asset Management

Passive 401(k) inflows buy the S&P at any price, so equities have no value anchor.

Harley argues the equity market is driven by money flows rather than valuation. Young workers max out 401(k) plans and auto-invest into index funds like SPY, so money keeps flowing in 'at whatever price it is.' With unemployment at 4.1%, contributions keep coming. Harley endorses Michael Green's view that passive is driving the market. Passive buying concentrates in less liquid mega-caps, which amplifies moves ('that keeps blowing and blowing the bubble'). He is clear that there is no value construct for equities anymore.

“because we have a 4.1 unemployment rate, you're gonna have money flowing into these retirement accounts, and it will buy S and P at whatever price it is. There's no value construct.”at 41:00

Harley Bassman · Simplify Asset Management

S&P out-of-the-money puts look cheap and are the best hedge, though he is not advising it.

Because rates exceed the S&P dividend yield, S&P futures trade above spot by a calculable carry. Strikes that look like 10% out-of-the-money in market terms are 12-14% out-of-the-money in the model, so out-of-the-money puts are cheaper than they appear. Harley calls them the best hedge if one wanted protection. He stresses he is not recommending the trade because he does not see a heartbreak coming.

“It would make out of the money puts cheap or cheaper because you might think you're buying a 10% out of the money put on the current level, but it might be a 12%, 13%, 14% out of the money put in the model.”at 45:39

Harley Bassman · Simplify Asset Management

Likes gold as a hedge against a suspect US currency, though it recently sold off on margin calls.

Because trust in the US currency is suspect, he likes gold and sees a flight out of Western paper into other assets. He expects foreign buyers to buy gold. Gold fell recently as rates rose and margin calls forced sales of what could be sold, but at about $4,000 it remains well above where it was two years ago.

“And what we're seeing now, I like gold. I like real estate, I suppose.”at 4:40

Harley Bassman · Simplify Asset Management

Silver's implied vol near 120 was too high; he sold strangles betting it wouldn't move that far.

During silver's wild January-February swings, implied volatility reached about 120. Harley judged that silver would not keep moving that much daily or over a year, so he sold strangles to capture the overpriced volatility. He sizes the trade by comparing implied volatility with his own expected move over the period.

“It was utterly insane. So I went and sold some strangles on that because I just did not think silver was gonna go and be moving that much every day or a year, move that far.”at 35:52

Harley Bassman · Simplify Asset Management

Government will inflate its debt away; inflation is a silent tax both parties accept.

Default is ruled out because the US issues dollars, and growth is not a realistic way out at this stage. That leaves inflation as the adjustment mechanism. Inflation is a tax that Republicans and Democrats can agree on because nobody votes on it. Taxing billionaires to zero would make no real difference, so the burden falls on the middle class.

“And we're gonna inflate. Inflation is the only tax that both Republicans and Democrats can agree on because you never vote on it.”at 5:00

Harley Bassman · Simplify Asset Management

Official CPI understates true inflation due to hedonic adjustments; breakevens look misleadingly calm.

The 10-year breakeven has sat near 2.35% for four years through large rate moves, which he reads as the market not pricing much inflation, but he thinks the measure is the problem. He argues CPI was dialed down in the late 1990s through hedonic adjustments and substitution, such as switching from beef to chicken. The government has an incentive to keep CPI low because Social Security benefits are indexed to it. Rising TIPS real yields may reflect investors who believe CPI understates real inflation, which he says costs such as housing, healthcare and college have been rising much faster than.

“What's wrong with this picture might be that CPI is cooked.”at 6:24

Harley Bassman · Simplify Asset Management

Economy is propped up by top earners; median households are squeezed as big costs outrun incomes.

Averages mislead: the mean GDP per capita looks strong because the top 0.1% to 10% earn and spend most income, while the median household is struggling. Over thirty to forty years, MBA starting salaries have roughly doubled while housing, healthcare and college costs have risen four to five times. His millennial children cannot afford to live in cities. Confidence and right-direction readings are falling, and he argues these cost increases run well above CPI.

“...the economy being kept aloft by the spending and the income of the 1%... They're making money and spending everything else, and everywhere else down below is getting killed.”at 8:24

Harley Bassman · Simplify Asset Management

Higher rates will cut credit-card spending, car sales and mortgage activity.

Harley says consumers are the price-sensitive part of the borrowing market. Higher rates will make credit-card users buy less, stop car loans from driving car sales, and hurt the mortgage market. He contrasts this with the government and hyperscalers, who keep borrowing regardless of price.

“Will credit card guys buy fewer things? Yeah, sure. Will car loans stop car sales? Yes. Will the mortgage market get hurt? Yes.”at 47:54

Harley Bassman · Simplify Asset Management

US fiscal path is unsustainable; interest costs could reach $2T a year as debt rolls over.

Deficit runs about $2T a year, with roughly $5T of income against $7T of expenses. Interest is already about $1.1-1.2T and Treasury is funding by issuing bills and buying back bonds. If about $40T of debt is refinanced at 5% as low-coupon debt rolls off, interest alone would reach about $2T, which blows past defense spending. He says the US cannot go bankrupt because it issues its own currency, but the path is unsustainable without an agreed plan for control. He says a debt spiral could take twenty years to play out.

“It is a 95% fiscal problem. ... This is unsustainable.”at 10:19

Harley Bassman · Simplify Asset Management

The US government will keep borrowing at any price, so rate rises won't curb it.

Harley argues the US government has no price at which it will stop borrowing, since it must borrow or default. Together with the hyperscalers, it is one of the two largest borrowers and is price-insensitive. Rising rates will therefore hit credit cards, auto loans and mortgages, but not the two biggest sources of bond supply.

“US government, there is no price where they'll stop borrowing. They have to borrow. ... So therefore, we have the two biggest borrowers, basically 2,700,000,000,000, who are totally price insensitive.”at 47:40

Harley Bassman · Simplify Asset Management

Fannie and Freddie's $200B mortgage-bond buying is too small to move a $7T market.

He dismisses the policy of directing Fannie Mae and Freddie Mac to buy $200B of mortgage bonds. Against a roughly $7T market, it won't dent anything; the market tightened by a dime for a week or two and then reversed. He calls these short-term coin flips rather than a real plan.

“When Trump had Pulte go and Fannie and Freddie buy $200,000,000,000 in mortgage bonds, that's not gonna dent anything. Talking a $7,000,000,000,000 market.”at 13:09

Harley Bassman · Simplify Asset Management

Housing is unaffordable for the median buyer, and higher rates would make it worse.

The housing affordability index has dropped well below 100 because incomes have not kept pace with home prices, which have not fallen much. Higher rates shrink the number of people who can afford a median home. Housing is about 18% of the economy, so higher long-end rates could eventually tip the economy into recession. Only wealthier families who can help with down payments are buying.

“Housing, it's unaffordable basically for most people.”at 25:00

Harley Bassman · Simplify Asset Management

Current oil price spike is transitory; it will fall once the war ends, unaffected by Fed rates.

He now believes the inflation pressure is transitory because the oil cost is transitory: it will come down once the war ends, though he doesn't know when. Oil isn't sensitive to the Fed's policy rate, so rate hikes have no real correlation with it. He had dismissed the word transitory three to five years ago.

“I kind of believe in it now because oil is a transitory cost. I mean, it will come down. The war will end.”at 15:41

Harley Bassman · Simplify Asset Management

High oil prices are choking demand, so the 'cure for high prices' is working there.

Harley agrees with the principle that high prices cure high prices, and says it is working in oil. The authorities or market are choking the oil price, and he expects demand destruction of some kind. He notes the effect has not yet become extreme. The argument is brief and not fully developed.

“I think it's working in oil. They're choking this thing off and probably seeing demand destruction of some kind.”at 47:10

Harley Bassman · Simplify Asset Management

Fed should cut 50bp once and stop to prove independence; dots and guidance breed moral hazard.

The Fed is in a box: hiking would hurt homeownership and raise government costs, while cutting could inflame inflation fears and push the back end out of control. He favors a single 50bp cut, one and done, which would show Warsh is not a Trump sycophant; Warsh lacked the votes for it. He opposes dots and forward guidance because they create moral hazard. He cites Greenspan's measured pace in 2004 that led hedge funds to take levered risk, and Silicon Valley Bank's failure after the Fed promised zero rates until early 2023. He also says QE beyond QE1 was a mistake.

“I do think that taking rates down at this stage of the game would be a fine idea, except it's going make Warsh look like he's a Trump sycophant, which he can't do. That's why I [am] in favor of 50 basis points, one and done.”at 28:41

Harley Bassman · Simplify Asset Management

Earlier this year markets priced too many Fed hikes; the forward rate was wrong and should be shorted.

When markets priced three hikes this year, the one-year rate one year forward implied about 2.5%. Harley says that is 'insanity' and will not happen, so the forward rate was mispriced and he would short it. He notes the curve is now dead flat, so there is no opportunity at present.

“earlier this year, when you had three hikes priced in, you could look the one year rate, one year forward and say, man, that's just the wrong price. ... That's insanity. That's not gonna happen. So you go short that rate there.”at 44:26

Harley Bassman · Simplify Asset Management

Trust in the US dollar is eroding; the government will debase the currency, as Japan's yen did.

The US runs a 6% fiscal deficit with no war or recession, and no one has control over fiscal policy. Default is impossible because the US prints its own dollars, so the adjustment will come through devaluation. He sees a lack of trust in the dollar locally and globally, and notes Western Europe and Japan are no better. He expects the dollar to follow Japan's path, where the yen went from 80 to 160 per dollar, though he is unsure what it will be measured against.

“Can we devalue that currency? Yeah. And I think what's happening here right now is we're just seeing a lack of trust locally and globally in the US dollar.”at 3:13

Harley Bassman · Simplify Asset Management

Non-bank private credit has exploded and replaced banks, so Fed policy controls less credit.

Non-bank lenders have grown rapidly, almost stepping into the banks' shoes. Banks are driven by the Fed, borrow from it, report to it, and follow its rules, so when front-end rates rise they raise the cost of loans. Private lenders are not beholden to the Fed, so the Fed doesn't control that spigot, and credit doesn't respond to policy in the same way.

“You've seen non bank private credit guys explode into the market, almost stepping into the shoes of the banks.”at 15:51

Harley Bassman · Simplify Asset Management

Hyperscaler bonds are money good because their core businesses generate enough cash to pay debt.

The five hyperscalers have to borrow heavily, but he judges their credit as sound because all five have core businesses that produce cash. That cash can cover coupon payments and probably principal too. Equity holders may take a hit, but bondholders are money good.

“they're probably money good because all five of them all have core businesses that produce cash.”at 17:10

Harley Bassman · Simplify Asset Management

Higher rates may not hurt growth; corporate net interest income is now positive, so hikes could help.

He doubts rate moves matter much because the economy runs on private bank lending and hyperscaler borrowing rather than Fed funds. He cites Albert Edwards' observation that US corporations' net interest income is now positive, so higher rates help cash-rich boomers and corporations earn more. He hedges that he could have this wrong, and he also says a rise in long-end rates could eventually throw the economy into recession.

“I don't think it actually impacts the economy. As a matter of fact, it might even help the economy because all of a sudden, all these cash rich boomers and cash rich corporations are gonna earn more money on their accounts.”at 27:25

Harley Bassman · Simplify Asset Management

Eliminating step-up basis and uncapping Social Security tax would raise revenue; wealth taxes won't work.

He expects politicians to uncap the Social Security payroll tax base, means-test Social Security and Medicare, and eliminate the step-up in basis, which lets gains escape tax at death. He thinks these changes could significantly raise revenue and narrow the deficit spread. A wealth tax, by contrast, is meaningless because the rich can game it, as it has in Europe. He argues the US had a balanced budget and surplus about 25 years ago, so the current deficit is self-inflicted.

“They're gonna go and get rid of the step up basis. ... I think things like that can significantly raise revenues, reduce that spread.”at 30:18

Harley Bassman · Simplify Asset Management

Unemployment rising above roughly 5% would stop passive inflows and trigger equity selling.

Harley says the equity market only turns when retirement-account money stops flowing in. That happens when workers lose jobs and stop contributing to 401(k)s. He pegs the threshold loosely ('four and a half, five, five? I don't know'). Boomers' mandatory withdrawals would then add to the selling, so passive flows reverse.

“Well, the answer is unemployment over 5%.”at 42:06

Harley Bassman · Simplify Asset Management

Hyperscalers will issue debt at any price; small yield moves won't stop their borrowing.

Harley argues the hyperscalers (Oracle, Meta and peers) are in an existential race for AI, so they will borrow regardless of cost. A move in their borrowing rates from around 6% to 8% or from 7% to 9% changes nothing. Their debt issuance is therefore insensitive to rate moves, which makes it a persistent source of supply.

“I already said the hyperscalers will issue at any price. At 20%, would they do it? No. If Oracle goes from six to eight, you know, Meta goes from seven to nine, does that matter? Not one.”at 47:20