Harley Bassman: Bonds Are Fully Cooked Without an Imminent Recession

Episode Summary

Executive Summary: Harley Bassman argues the Fed’s path is now broadly known, making the long end of the Treasury curve “cooked” and interest-rate volatility overpriced. He favors selling volatility via current-coupon mortgages, callable agencies/munis, and his MTBA new-issue mortgage strategy, while also betting the market is too aggressive on future Fed cuts. He sees modestly higher long rates, sticky inflation, and reduced sensitivity of the real economy to rate changes.

Main Topics: Fed path and the Treasury curve (Priority: 5/5): Bassman thinks the market now understands the Fed’s plan, limiting downside in long rates and making the back end of the curve unattractive for further yields declines. Selling interest-rate volatility (Priority: 5/5): He argues implied volatility in rates is too high versus realized volatility, creating opportunities to sell convexity through mortgages, callable agencies, and munis. New-coupon agency mortgage strategy (MTBA) (Priority: 5/5): Bassman explains why Simplify’s new-issue mortgage ETF focuses on near-par, higher-coupon agency MBS to capture better yield and embedded optionality than the mortgage index. Bank failures and duration risk (Priority: 4/5): He uses Silicon Valley Bank and similar episodes to show how unhedged duration plus overnight funding and misplaced trust in Fed guidance can destroy balance sheets. Fed cuts vs market pricing (Priority: 5/5): He believes the futures market is too dovish and that the Fed may not cut as much as priced, making front-end short positions attractive. Inflation, demographics, and long-run rates (Priority: 4/5): Bassman links sticky inflation to demographics, arguing millennials’ household formation and retiring boomers support persistent demand and higher nominal rates than markets expect. Portfolio construction and sizing (Priority: 3/5): He emphasizes that position sizing matters more than entry point and favors diversified, measured exposure rather than trying to perfectly time markets.

Key Arguments: The back end of the curve is unlikely to rally much further because the Fed’s policy path is already well-telegraphed, so long duration has limited upside. Interest-rate implied volatility is expensive relative to realized volatility, so selling options/convexity is more attractive than buying protection. New-issue agency MBS are better value than the mortgage index because they carry higher coupons, higher yield, and more monetizable optionality near par. Mortgage bonds are effectively covered calls on rates: homeowners have the right to refinance, which caps upside but creates value if optionality is mispriced. SVB’s failure was fundamentally a duration-and-funding mismatch problem, worsened by relying on the Fed’s guidance and not hedging properly. The bond market and Fed funds market are pricing too many cuts versus the Fed’s own dots, especially in the front end. Long rates should settle higher than current levels because nominal GDP and inflation imply a higher equilibrium 10-year yield. Rate hikes were less damaging to borrowers than to lenders because many corporations and homeowners locked in long-term debt at low rates; the same asymmetry likely means cuts will be less stimulative than expected. Sizing matters more than picking the exact top or bottom; investors should avoid overconcentrating in any single view or instrument.

Data Points: Fed rate cut: 50 basis points - The interview takes place about a week after the Fed’s cut. Fed funds futures (2026): ~2.8% - Referenced as market pricing for policy rates over the next few years. Fed dot plot long-run / 2027: 2.9% - Used to frame the Fed’s expected easing path. 10-year Treasury yield: ~3.75%-3.80% - Current level discussed as too low relative to Bassman’s view. Bassman fair value for 10-year: ~4.0%-4.5% - He thinks the long end can rise modestly but not spike back to 5%+. Cash Treasury curve 2s/10s: +17 bps - Current Treasury curve inversion/shape referenced. SOFR/LIBOR derivatives curve 2s/10s: -9 bps - He notes the swap/derivatives curve remains inverted. Investment-grade credit spreads: 52 bps - Cited as unusually tight/rich. MOVE index: 92 - Implied Treasury volatility measure, down from prior highs. MOVE realized volatility: 65 bps normal volatility - He compares implied to realized volatility to argue vol is expensive. MOVE peak last year: 120-140 - Shows how much implied vol has fallen from prior levels. S&P realized volatility: 14+ - Used in comparison with VIX. VIX: 15+ - Illustrates equity vol is only modestly above realized vol. Mortgage bond yield spread: 115 bps over Treasuries - Current agency mortgage spread cited as attractive. Corporate bond spread: 52 bps over Treasuries - Used to contrast mortgages vs corporates. Long-term average mortgage spread: 70-75 bps - Bassman says mortgages are richer than average but still compelling. MTBA assets: ~$1.4 billion - Simplify’s mortgage ETF has grown organically since launch. MTBA launch timing: November - He references launching the product last November. MTBA duration: ~3.5 - Compared with the mortgage index’s much longer duration. Mortgage index duration: ~6-7 - Illustrates why the index is more rate-sensitive. Treasury/MBS spread example: ~20 bps - He notes REIT leverage becomes attractive when funds rate falls below mortgage yields. Mortgage REIT leverage: 7-10x - Used to explain how REITs benefit as front-end rates decline. December 2025 Fed funds contract: ~2.9% - He believes this market pricing is too low versus Fed guidance. Fed dot projection for 2025: ~3.4% - Used to show a gap between market pricing and the Fed. High-yield credit spread: ~300-307 bps - He considers junk spreads tight versus historical risk. Nominal GDP: ~6% - Used to argue 10-year yields should not be far below 4%. Mortgage rate example: ~5% - He cites Fannie 5s near par in the discussion of REITs and MBS. Bank deposits funding rate: 0.5% to 5% - Illustrates the cash-flow squeeze on banks when rates rose. Corporate net interest payments: Positive/earning money - He says corporate America is effectively earning on some long-term debt structures now.

Pivotal Quotes: "The back end of the curve is cooked." — Harley Bassman: His core view on long-duration Treasuries and limited upside for yields to fall further. "Sizing is more important than entry level." — Harley Bassman: His portfolio-construction advice: position size matters more than perfect timing. "You want to sell interest rate vol." — Harley Bassman: His main trading recommendation given high implied volatility versus realized volatility.

Implications: Listeners should expect Bassman’s framework to favor selling rate convexity, leaning into agency mortgages and callable structures, and being cautious on aggressive duration bets. His broader message is that markets may be overpricing cuts and underpricing sticky inflation and range-bound rates.