MacroVoices #449 Harley Bassman: The Magic of Mortgages

Episode Summary

Executive Summary: Macro Voices episode 449 centered on Harley Bassman’s bullish case for agency mortgage-backed securities, especially newly issued higher-coupon pools versus the legacy mortgage index. Bassman argued MBS are attractive because high implied volatility and an inverted yield curve make the embedded call option expensive, and that risk-adjusted returns are superior to Treasuries and credit. The post-game noted oil volatility, a continuing equity melt-up, a firmer dollar, a gold consolidation, and improving uranium sentiment.

Main Topics: Why mortgage-backed securities are hard to trade directly (Priority: 5/5): Bassman explained that agency MBS are a huge bond asset class, but retail investors rarely trade them directly because amortization, reinvestment risk, tax complexity, and principal paydowns make them operationally awkward. Most exposure comes via ETFs and mutual funds. MBS as a call option on rates and volatility (Priority: 5/5): He framed MBS as a buy-write structure: the bond plus an embedded call option reflecting borrowers’ ability to refinance. The option value depends on interest-rate levels, forward rates, and implied volatility, which currently make MBS cheap or expensive relative to Treasuries. Why newly issued higher-coupon MBS are preferred (Priority: 5/5): Bassman argued that the best MBS exposure is in newly issued near-par pools with coupons around 5% to 5.5%, not legacy low-coupon bonds. Higher coupons have larger embedded option value and better risk/reward than older low-coupon mortgage indices. Curve inversion, forward rates, and MBS pricing (Priority: 5/5): The discussion emphasized that inverted yield curves push forward rates below spot rates, causing models to value the embedded mortgage option as if it is already in the money. That increases option cost and widens MBS spreads versus Treasuries. Inflation, demographics, and the macro backdrop (Priority: 4/5): Bassman said the macro environment likely keeps inflation and rates range-bound rather than collapsing. He tied this to boomer retirements, later millennial household formation, immigration-driven labor supply complexity, and a belief the Fed has largely found the inflation/rates equilibrium. ETF structure and regulatory change enabling the strategy (Priority: 4/5): He noted that SEC rule changes allowing derivatives in ETFs made it possible to package active MBS and rate-option strategies into public vehicles, including Simplify’s approach of holding and rolling newly issued mortgage exposure. Post-game market snapshots: oil, equities, FX, gold, uranium (Priority: 3/5): Eric and Patrick reviewed a strong oil squeeze, an equity melt-up into the election, a bounce in the dollar, a gold pullback that may set up new highs, and signs of a uranium bottom.

Key Arguments: Agency MBS are the second-largest bond asset class after U.S. Treasuries, but are underowned directly because their cash flows amortize and create reinvestment and tax headaches. An MBS should be modeled like a bond plus a sold call option; the key driver is the value of that option, not just credit quality or maturity. The inverted yield curve makes forward rates look lower than spot rates, increasing the embedded option’s value and widening MBS spreads. Volatility in rates remains elevated versus realized volatility, making convexity/option-seller strategies attractive right now. Legacy mortgage indices are dominated by low-coupon bonds, which have poor risk/reward because they behave like deeply out-of-the-money options sold for pennies. Newly issued, near-par, higher-coupon mortgage bonds offer the best convexity profile and are the most attractive way to express the view in retail ETF form. Bassman does not need Treasury yields to fall for the trade to work; he mainly needs the front end to come down relative to the long end, steepening the curve and reducing option value. He sees inflation staying elevated, not due to a return to 1970s-style extremes, but because demographics, labor supply changes, and household formation dynamics support a higher structural floor. He is unconcerned about agency MBS credit risk because Fannie/Freddie underwriting standards are much stricter than pre-GFC and government backstop risk is viewed as remote. Post-game commentary framed crude oil as volatile and geopolitically supported, equities as likely to keep melting up into the election, and gold as correcting within a broader uptrend.

Data Points: Macro Voices episode: 449 - Episode number for the feature interview Production date: October 10, 2024 - Episode release date December S&P 500 futures: up 141 bps to 5841 - Week-over-week market scoreboard U.S. dollar index: up 125 bps to 102.87 - Week-over-week market scoreboard November WTI crude: up 448 bps to 73.24 - Week-over-week market scoreboard November RBOB gasoline: up 352 bps to 206 - Week-over-week market scoreboard December gold: down 161 bps to 2626 - Week-over-week market scoreboard Copper: down 538 bps to 4.40 - Week-over-week market scoreboard Uranium: up 158 bps to 83.50 - Week-over-week market scoreboard U.S. 10-year Treasury yield: up 27 bps to 4.07% - Week-over-week market scoreboard EIA crude oil inventory: +5.8 million barrels - Post-game oil discussion Gasoline inventories: -6.3 million barrels - EIA weekly data offsetting crude build Distillate inventories: -3.1 million barrels - EIA weekly data offsetting crude build Net petroleum drawdown: -3.6 million barrels - Combined product and crude inventory move Cushing, Oklahoma inventories: +1.2 million barrels - EIA weekly data Typical MBS spread over Treasuries: ~75 bps historically - Bassman’s long-run reference point Recent MBS spread range: ~150-170 bps - He said MBS widened dramatically during the inversion/vol spike MOVE index recent level: ~125 - Bassman’s estimate of current rate volatility MOVE index prior high range: ~160-170 - Peak recent volatility referenced MOVE index traditional range: 80-120 - Historical range Bassman cited as normal Realized rate vol: ~75 - Bassman said implied vol is well above realized vol Implied rate vol: ~125 - Used to justify selling convexity/optionality Agency underwriting FICO threshold: above 720 - Bassman contrasted agency loans with pre-GFC subprime

Pivotal Quotes: "Mortgage-backed securities are probably the best way to invest risk-adjusted in the bond market." — Harley Bassman: Core thesis on why MBS are attractive relative to other fixed-income sectors "Bonds are cooked." — Harley Bassman: His shorthand for a view that rates have largely found their long-term range "If you think Fannie and Freddie have a chance of going down, you should be buying gold, guns, and cans of tuna and live in a cave." — Harley Bassman: Emphatic dismissal of agency MBS credit-risk concerns

Implications: For fixed-income investors, the message is to favor convexity-rich, near-par agency MBS over low-coupon legacy pools or tight credit. The trade benefits from high implied rate vol, a less inverted curve, and a range-bound rate outlook.