Where The Next Big Bond Trade Is Hiding | Harley Bassman

Episode Summary

Executive Summary: Harley Bassman argues the bond market is mispricing the speed of Fed cuts and that a fast move to 3% funds rates would imply a crash landing not supported by current data. He says the long end is near fair value, credit is tight, and the best opportunities are in selling expensive rate volatility/convexity, especially via mortgage-backed securities and callable munis.

Main Topics: Fed pricing vs. market pricing (Priority: 5/5): Bassman explains that forward rates are break-even arbitrage prices, not forecasts, and says markets are pricing a much faster easing path than the Fed’s dots imply. Yield curve inversion and market distortion (Priority: 5/5): He argues that QE and Treasury issuance have distorted the curve, reducing its informational value and contributing to moral hazard. Fair value of the long end (Priority: 4/5): Bassman links long-term Treasury yields to nominal GDP and argues the 10-year below 4% looks hard to justify absent a severe crash landing. Convexity/volatility as the best trade (Priority: 5/5): With implied bond volatility far above realized volatility, he prefers selling rate optionality rather than taking duration or credit risk. Mortgage-backed securities and callable muni spreads (Priority: 4/5): He says mortgage spreads widened because embedded option values surged, creating an opportunity in newly issued higher-coupon mortgages versus corporates. Inflation, demographics, and fiscal deficits (Priority: 4/5): Bassman says structural inflation is driven by labor force growth, immigration, household formation, and boomer retirement, while deficits will likely be reduced via inflation over time. Credit markets and equity implications (Priority: 3/5): He sees corporate credit as tight but not a bargain, views small-caps as not especially attractive, and thinks equities can rise with nominal GDP even in a higher-inflation world.

Key Arguments: Forward rates are arbitrage-free break-even prices, not predictions of future policy or inflation. The market is pricing a much faster decline in the Fed funds rate than the Fed’s own dot plot; Bassman thinks the market is too aggressive. A move to 3% funds rates within roughly a year would imply a crash landing, which current GDP and nominal growth data do not support. QE and Treasury issuance have effectively acted like soft yield curve control, distorting the term structure and weakening the market’s feedback loop. The 10-year Treasury should broadly track nominal GDP over time; with nominal GDP near 6%, sub-4% 10-year yields look low. The most attractive fixed-income trade is selling expensive convexity/volatility rather than extending duration or taking more credit risk. Mortgage-backed securities, especially newly issued higher-coupon paper, are attractive because embedded option values are still rich versus historical norms. Credit spreads are tight and offer little margin of safety, especially if a hard landing materializes. Secular inflation pressures come from demographics, labor force growth, immigration policy, tariffs, and boomer retirement, not just near-term Fed cuts. Inflation can function as a quiet way to reduce debt-to-GDP over time, while equities can keep pace with nominal GDP in nominal terms.

Data Points: Permissionless 3 dates: October 9-11 - Conference promo at the start of the episode Conference location: Salt Lake City - Permissionless 3 location Discount code: FG10 - Promo code offered for 10% off conference registration Fed funds futures implied rate: ~2.95%-3.0% - Market pricing for roughly one year ahead Fed terminal rate discussed: ~2.75% - Bassman says both market and Fed broadly agree on terminal level, but not timing Atlanta Fed GDPNow: ~3% - Used to argue the economy is not in recession Nominal GDP: ~6% - Bassman’s benchmark for long-end fair value 10-year Treasury fair value view: under 4% is hard to justify - He says 10-year yields should not fall much below 4% absent a crash landing Fed funds to 2-year spread: ~50 bps - Traditional relationship cited by Bassman 2s10s spread: ~75-100 bps - Traditional relationship cited by Bassman MOVE index: ~95-100 - Current implied bond volatility level he cites MOVE index peak: ~130-150 - Last year’s higher volatility regime Realized bond vol: ~68 - One-month realized volatility cited as lower than implied CDX IG spread: ~52-55 - Used to show investment-grade credit is tight 30-year mortgage rate: sub 6.2% - Mentioned as a high-frequency indicator of easing financial conditions Budget deficit: ~7% of GDP - Bassman says this is unsustainably high in peacetime Corporate refinancing wall: 2026 is a major maturity peak - He says maturities are building next year and especially in 2026 Mortgage option value example: 4 points historically vs. 8 points at the peak, now around 6 - Illustrates why mortgage spreads widened

Pivotal Quotes: "Forward rates are not a prediction of the future. They’re the arbitrage-free price where there’s no money can be made." — Harley Bassman: Explaining what implied forward rates mean "It’s not pricing in a recession, it’s pricing in a crash landing." — Harley Bassman: His view on the market’s rapid easing expectations "The more the Fed uses forward guidance and dots, they create moral hazard." — Harley Bassman: His critique of Fed communication policy

Implications: Listeners should watch the front end of the curve, not just recession headlines. Bassman’s framework favors selling rich volatility and being selective in mortgages over chasing duration or credit, while expecting inflation and nominal growth to stay structurally higher.