Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.
And I'm Joe Wisenthal.
Joe, you know what one of the weirdest things about twenty twenty three was. I mean, I guess there's that's an unfair question, isn't it.
Why don't you just tell me what's on your mind? And you know I could make many guesses, but why don't you just tell me?
So after all the drama in the bond market, all the ups and downs, all the volatility, we basically ended the year kind of where we started, right around three point eight percent all the ten year yield. And I know it's picked up a little bit since then, but we basically had this really round trip, but a lot happened in between.
That was a great choice, Tracy, for one of the weird things that happened. Yes, that was a huge story throughout the year, bond sell off, higher rates, et cetera. And then to get to the end of December and say, oh, yeah, the ten years basically where it started the year, extremely strange and unexpected. And when I saw that stat, I was like, I did not anticipate that at all.
Yeah, and to me, maybe this is going to be a bit of a tortured analogy, but twenty twenty three is sort of emblematic of the bond market overall. People tend to look at it and think it's super boring. Normally, you know, before the wild years of twenty twenty one, twenty twenty two, twenty twenty three, it didn't move around that much. You know, bonds were supposed to be boring
in that sense. And I think people have this view of like, Okay, you buy a ten year or maybe you buy a tip or something like that, you invest in t bills to get a little bit of pickup, or maybe you sell some bonds, and that's basically the extent of investing in the bond market. But there's this whole world when it comes to trading fixed income and interest rates that gets really interesting, really complicated in some ways,
and I feel like we don't talk about enough. Like every once in a while it hits the headlines, Like you know, when Bill Gross was talking about selling volatility before he left PIMCO, everyone was like, oh, wait a second, there's a big bond investor selling volatility. I wonder how they're actually doing that. Yeah, but more often than not we talk about yields, we kind of connect them to what's going on in the macro economy and inflation and maybe the US debt and that's it.
No, you're you're totally right. I mean, there's really two things. I mean, a part of the story for bonds over the last two years was the end of this incredible like forty year bond bullmarket or treasury bull market. And there were a few interruptions, of course in ninety four, etc. And we know about that, but by and large, bonds went up, yields went down, and bonds were like a nice heg hedge against your you know, your equity portfolio
and sixty forty type portfolios were great. But then the other thing is you say, like if you talk to an equity manager, oh, I like tech docs this year, I like energy, you know though, just some rotation. We like big cabs, like small cabs. We like international. But it's like different flavors of being long. Whereas you know, when you look at how a lot of fixed income portfolio managers invest, as you say, it is often various flavors of derivatives around fixed income or you know, spreads
and things like that. Rather than just sort of long here, long there exactly.
So I am very pleased to say that today we do, in fact have the perfect guests to talk about the intricacies of fixed income. We have someone who actually used to work at PIMCO. He's now managing partner at Simplify Asset Management, perhaps better known as the convexity maven. So we're going to be speaking to Harley Bassman. Harley, thank you so much for coming on the show.
Thank you, good morning.
Very excited to have you here. I should have added to your intro that you are also a master of colors.
Right, which we were going to get into the best color line charts in the business.
Thank you.
So I have a question to begin with, and this is completely out of self interest as a journalist who's had to write about convexity at many times during their career and has always struggled to define it in a way that satisfies my editors who want to encapsulate a financial relationship in as few words as possible. How would you describe it?
You know, convexity. It's it's an ex word. So everyone gets a little rattle about that, but it's actually rather simple it's just unbalanced leverage, which was also a hard concept. Let's simplify it a little bit. If you have a bet, you're making a wager where you make a dollar or lose a dollar for equal up and down opposite payoffs, that's zero convexity. If you make two dollars and lose one, that's positive convexity. If you could lose three and make
two negative convexity. The reason why we hired all these you know PhD you know quants in the nineties was to basically figure out what that's worth. Clearly, you'd rather own some makes two and loses one that is one to one, and if it's lose three make two, you better get paid for that. So all the mumbo jumbo we go do around pricing out these various paths and payoffs is just to make it up a fair bet when you have these different payoff profiles, and that's it.
Covexy just means that the payoff is not linear, it's not one to one.
Every once in a while you get to do something really great on this podcast, Joe and asking the convexity maven to define convexity is one of those things.
This was a historic moment. We're gonna clip that. But let's go further down that. So often you hear about, like the most common time you hear about the phenomenon of convexity in the fixed income world is often related to mortgage related securities. Can you then, uh, can you take it a step further and sort of give us what does it mean? So you describe, you know, the search for positive, naturally occurring positive leverage in the world.
Give us sort of a concrete example. Why does this pop up when we talk about mortgages frequently?
Well, you're probably backing into the idea of our mortgage is a good value right now or not. Let's just go one step back. Yeah, when you're in the bond market, cod equities, the bond market, you have three buttons you could push. That's it, okay, Duration, credit, convexity. Those are your three risks. You start with cash, overnight cash, and anything you do past there is taking one of those three. Duration is when you get your money back. Credit is if you get it back. Convexi is how you get
it back. And what a bond manager is trying to do is move around those three buttons to find the best risk return, the best value. Presently, selling convexity in the bond market is the best thing to do out there right now. What's duration? It is when you get your money back, So a to your security'll move one point eight points for a one point move, So if rates go from four to five, to your bottle move by one point eight points, a tenure by about eight points,
a thirty year by be seventeen points. You're usually paid more to take longer maturity risk because there's more uncertainty. An infinite curve is kind of upside downland because you're getting paid less to take more risk. We could talk why that is in a little bit, but right now, duration is a very weird place to take risk right now, because you're paid less to go out the curve, and by a tenure versus a two year versus overnight cash credit.
Right now, investment grade credit is trading about fifty seven basis points. It's a little over half point over the over the yield curve, and you get that from looking at these interest rate derivatives. On your Bloomberg is gonna be CDX five year. That's actually tighter, a smaller number than its historic average of about sixty five sixty six
you're paid fifty seven. Now junk bonds you're paid about three sixty three point fifty three seventy, which is also much tighter than it's usual for forty four to fifty four to sixty. So going into credit now, yeah, you know that's not a great bet. I mean, I would say it's a disaster, but I mean, considering we're concerned about the possibility of overtightening, a possibility of procession, which an inverted curve kind of signals I don't wantally want
to go and take credit risk. Convexity right now. The move index, which is a measure of the price of convexity the same way.
It's which you invented, right I did.
It's the mix of bonds, plain and simple, the VIX of bonds. Its average is maybe ninety or one hundred. It's treating one twenty now, which averages out to about maybe seven eight basis points a day of market movement. That's higher, much higher than it's historical average. That's the kind of trade you want to go and do. And mortgage security is simply a glorified by right, That's it.
Wait, can I ask at a moment like this, when, as you point out, there does seem to be a lot of uncertainty. You know, some people are still saying that there's a lot left to do when it comes to stamping out inflation, but the market is already pricing in rate cuts and some people are still worried about
a recession. Is the important thing to choose which of those risks you want to take on duration, credit or convexity, or is the important thing to do to identify the exact right expression of the trade.
Well, clearly, if you know where rates are going to go, you just go and buy futures contracts to call the day. I assume that we don't know where the market will be usually, and therefore, when you're building a portfolio, what you want to do is you're always going to have some exposure to all three of those. What you're trying to do is over or underweight these various sectors, depending
upon your market view. So right now, what I'd be doing is overweighting the convexity, underweighting the credit, and then duration I'd be pulling into the five year or earlier on the curve. For a variety of.
Reasons, explain this further when you say, okay, you want to be going long convexity, or that's where the opportunity is because if you say the move index, your creation is higher than normal. Unlike say, you know you're not getting paid for credit. How do you express that trade of going long convexity and what does that look like?
Well, actually we're going short.
Sorry.
In general, I tend to be a long covexity person and I like the idea of making two losing one. So I've done most of my career owning covexity, owning optionality. However, as they say, no bad bonds, just bad prices, there is a level where I will sell it, and we're at that level right now. Before the FED came in scrambled things up in the last decade, the old rule was on the move you buy eighty, you sell one twenty.
The problem with that is nobody would do it. Why is that when the move got down to you know, seventy eighty, that means the market's not moving that much. And therefore, who wants to go and buy optionality? Who wants to pay time decay when the maruk's not moving? No one does so no one buys it when it's low, and when once twenty or higher no one sells there you have some crazy event going on. People are hiding under their desks crying for mommy. So no one sells
it at one twenty. But the reality is you're supposed to go and you know, not go naked short optionality. But you can go and just bias what you do to make yourself either short COVEXTI or maybe it's a little less long convexity in your portfolio, just.
So that we can like when you say, like, okay, short convexity, what is the type of instrument that allows any trade or investor to express that?
Well, the most simple strategy would be for an investor on the stock portfolio to go and sell covered calls. I mean that's that's I mean you're selling options, selling AVEXDI when you when you go, when you sell covered calls, what are you really doing? You're kind of converting potential capital gains to current income. You're limiting your upside, you're downside. Of course you're still large, but stock can go down a lot, but you're basically kind of doing a conversion
there of taking risk off the table. For current income, and there's a price where you want to go and do that, and there's prices where you don't. When the VICS is at forty or fifty, I mean, you probably want to sell covered calls. Of course you won't do it because you'll be a panic, but that's kind of the idea. And theoretically, portfolio managers supposed to have no blood in their veins and they can go and do these various trades when the time is right.
This is why I'm not a portfolio manager, Jery, I in fact have blood. But actually this brings me to a question I always wanted to ask, because a lot of your trade ideas, I think they're publicly available. So like every year you publish stocking stuffers, which is kind of a series of trade ideas, and I'm never quite
certain who those trade ideas are aimed at. And the reason I say that is because you will say stuff in them, like you know, and if you don't have an is to credit agreement, here's a way to get around that. But then the trade itself is still quite complicated, so I assume it's not aimed at your average retail investor. Who is the target audience? For some of these things, well.
I'll say that as my career's gone by, I used to target high institutions and hedge funds. I've now moved more towards I would call it reasonably intellectually sophisticated high networth retail as if you're towards an average person, probably not. But you can still take these ideas and take the flavor of them. You don't have to do the exact idea. You could just do the flavor. So if it's a duration concept, you can take your portfolio from a ten
year area to a five year area. If it's a credit area, you can move into single A from double A, things like that. But yes, you're right, a lot of ideas are a little a little tricky and entertaining hopefully also but yeah, yeah, it could be a challenge.
They are always entertaining, that is definitely true. But you know, if you say something like short convexity for a simplified trade, I would think do something with the MBS index. But that's not what you're advocating at all.
Not right now. Well, my new job I'm with I hate to give a plug over here, but I'm at simplify asset management. And what we are doing is we're taking a lot of the ideas that I've had and putting them into ETFs. There was a SEC rule change a few years ago that allowed people to put drives of futures options, all these various things into ETFs, and what we've been doing is putting these derivatives into ETFs
which you could basically point and click on Robinhood. So, for instance, two and a half years ago, I created an ETF where I put a seven year put option on the thirty year treasury more or less into an ETF. And this was actually I think Bloomberg rank is one of the highest return trades for a while.
I mean from is this the pfix ETF.
Yep, it was up to two hundred percent for a while, and it's basically a straight up, you know, way to make money if rates go up. That was it, and it was a way for civilians to get to institutional products. And I have a new product out there where it allows civilians to go and buy mortgage bonds. Mortgage bonds are it's the second biggest asset class of bonds after treasuries, and it's almost impossible to buy them for ordinary people
for a variety of reasons. And what we've done is we have institutional quality trading abilities that we could put into ETFs. We're allowing enabling civilian investors to buy mortgage bonds that are trading, you know, near near par and right now, these par mortgage bonds, bonds trading near ninety eight nine nine one hundred are what I view to be the best fixed income investment on the planet right now, they're trading about one and a half points O.
Wait, sorry, what instruments are the best fixed income in in the planet?
Near par So near us right now? Five five and a half percent of mortgage bonds.
Okay, and how come sorry you were about to explain it. Why are they the best investment right now?
Well, mortgage bonds, for all intents and purposes, are US government guaranteed. Fany and Freddy are not guaranteed per se, Jinny May are. I can assure you Fannie May will never go bankrupt. If it was to go bankrupt, my advice then is to go buy cans of tuna, a gun, and small denomination gold coins because it will be the end of civilization. Okay, So Fano Ma is not going bust.
You could buy these mortgage bonds yielding about five and a half percent right now, which I can help you go and do, which is about one and a half percent over treasuries. Corporate bonds that can default are only fifty seven basis points over treasuries. And this is kind of crazy town where you could buy full faith and credit of the US government almost one percent higher than a corporate bond that can default, and if you are a believer in a hard landing, will default. Okay.
But the risk with the ns, like the normal mbs that you would see in the index, not the stuff that's trading really close to par that you're picking out, is pre payment risk, right, That's what you're trying to avoid.
So I think the better question is, excuse me, why are these mortgage bonds trading one percent higher than corporate bonds when clearly they are smart people in the world. The reason why is a mortgage bond looks and barks a covered call like you're selling this big call option on a ten year treasury and with the move at one twenty, that's the way you basically do a covered call. This is the way you go and take convexy risk. As opposed to credit risk, these par mortgage bonds can
be prepaid. Therefore, a bond trading at ninety nine, maybe you can go to one oh two, one oh three, one oh four before it gets called. That's what you're giving up when you buy a mortgage bond, is you're giving away the big upside. So if rates go from four to two, a par mortgage bond not gonna be so good. I mean you'll make money, you'll just a lot less. And if rates go up, these bonds will go down like a seven year treasury.
Uh, you mentioned credit risk just then, at this point in the economic cycle, how worried are you about credit risk? Given that, you know, going into twenty twenty three, there were a lot of recession fears. There were a lot of credit experts that explicitly said they thought that defaults were going to pick up substantially, things were going to
start to fall apart in the credit market. And instead, you know, November December we saw a pretty big rally in the space, leading to very low spreads, which you've already pointed out are kind of in crazy town territory at least compared to some other possible investments. So how worried are you about things like defaults in twenty twenty four.
Defaults in twenty twenty four not going to happen next year. They might when we have to refinance all the debt that was taken out. This is called the maturity wall, and there's plenty of grass and.
Charge on this podcast. You have to say looming maturity wall.
That's okay, looming. Yes, well it's looming, but it's coming. So I'm more interested in inflation than in default than in hard landing ideas. And the reason why is I think that the demographic of these boomers retiring retiring with a lot more money than their parents had, which means they're gonna keep on spending. The old rule was when you got older and you retired, you're spending was reduced because you had lower income. The boomers, well, we took all the money. Okay, I'm sorry.
At least you're honest about it. I appreciate that we.
Took all the money with the stocks, with the bonds, with the housing, with everything else. And so we're gonna keep on spending, but we're not going to work anymore. So we're pulling out the supply of labor. Right, the millennials, they're working, and they're getting married, they're having kids, so
they have just demand they need. They're going to buy stuff as they form households, and that's what I think is going to keep inflation pressures up the same way we had inflation in the seventies as the boomers right matured, formed households baugh cars. So I'm a believer that inflation the two percent target is not coming anytime soon. There's a good story why it, Mike, I'm not a believer in that. And I also think that the Fed is not gonna take rates down nearly as much as the
market is implying by the futures market. And I think that J. Powell good guy, bad guy. I don't know. What I know is this. He has a lot of money, his nice family, nice kids, probably a nice house. Also, what does he care about? What do we think of?
That is?
What is humanity all about? We still read the Greek tragedies, we still read Shakespeare. What did these guys all talk about that it's still so interesting three thousand years later. Hubris ego, that's what drives humanity. It's always the fault of humanity. And I think what Jay Peale's thinking about now is really not inflation per se. But what's my tombstone going to say?
Yeah, legacy is a nicer way of saying, Ego.
Is it gonna be Arthur Burns, who basically we all as the post your child for inflation getting out of hand? Or is it going to be Paul Vulgar the Saints who saved it from inflation. Some people will say that it wasn't him, it was demographics, but whatever, whatever, he wants to be Vulgar, not Burns, and therefore he's going to go. And I think hold rates up longer than people might think to go and ensure inflation is truly wouldn't stake in the heart dead.
So I mean, I definitely want to get more into the sort of I don't know, maybe a psychological approach to forecasting defense. Maybe we spend the rest of the show on that. But I do want to go back and talk the sort of boring stuff about the mechanics of mortgages real quickly on spreads. So the spread between the thirty year I just did like a subtraction function, the most crude thing, but you know, thirty year mortgage
minus thirty year treasury. You know a few years ago that spread was I don't know, like around one percent. It got as high, you know, got around three and a quarter. It's come down a bit two point eight. So just why are spreads as high as they are? How would you describe that gap between mortgage spreads and treasuries right now? Why is it still such historic hize?
Okay, you're supposed to you the par mortgage rate on Bloomberg mtge fncl use that, okay, versus the tenure swap rate or the tenure treasury rate.
The very much different. Right.
You'll see about a seventy five seventy basis points spread historically back you know, thirty forty years. Okay, it's now one fifty. Why is it? There? Two reasons. The easy one is vall is high, the moves at one twenty. That's the easy one. The harder one is that the curves inverted. That's going to require a lot of explanation that you can go look at my commentary on my
website to go read about. But those two things, the inverted deal curve and high volatility, and you're gonna see when this curve steepens out, which means a two year rate comes down below the ten year rate, you're gonna see mortgage bonds in general go up. You'll see mortgage yields come down, You'll see the retail mortgage rate come down. So that's coming, not yet, that's coming.
Wait.
But one of the questions about the recent dynamic and mortgage rates is it has fallen quite quickly, even though the spread between mortgages and treasuries is quite wide. I
think that's the question, like, why is it? It moved up really quickly in twenty twenty two to twenty twenty three, shot above seven percent and then eventually eight percent, But now it seems to be falling really quickly, even though a lot of people thought there were structural changes in the market that meant rates were not going to be able to come down that fast.
Look, as I said, the mortgage bond market is the second biggest market after treasuries. That spread of one point fifty drives the retail rate, and the retail rate is going to be let's say another three quarters to one percent over that rate. It's a business, and it's a competitive business, and it kind of grinds along. And so as you see the mortgage bonds tightened have a smaller spread to treasuries, you will see the retail mortgage rate
come down. You're also going to see the spread between the retail rate the rate the homeowners take versus the mortgage bond rate that's going to come pressed in also for a variety of market reasons.
This might be a slightly unfair question, but do you have an estimate for how far the mortgage rate could come down?
Oh? Yeah, I mean eventually the Fed will cut rates and you can see easily another hundred based points in mortgage rates, haven't.
I wanted to ask you about something else that you sort of threw in there, the inverted yield curve, And this has been a massive topic of conversation for the past couple of years. I mean, even before the pandemic, the yield curve was inverted, and so the joke was that the treasury market predicted COVID nineteen and things like that.
But when you look at the yield curve now it's been inverted for a while, there's this big discussion over whether or not it is still valid as a recessionary indicator. What economic information, if any, are you getting out of the inverted yield curve. What is it telling you?
If you go look at various derivatives, It's indicates right now that are to cut rates, you know, four or five six times so called one hundred and twenty bent basis points of cutting in the next year, which seems kind of crazy unless we crash market. We have a market crash. I think what's happening is this. I don't think it's the market predicting that rates are going to come down by one hundred and a quarter base points.
I don't think that's it. I think what's happening here is like an eighty five percent chance their rates don't move and a fifteen percent chance their rates go to one percent that we have some kind of disaster. It's it's a bimodal and if you add those two things together, that's how you get the down one twenty five. No one's saying one twenty five. I think it's zero and four hundred and people are using the two year rate or the five year rate as an insurance policy against
a bad thing happening. If you think in those terms, it kind of makes sense because we only quote one number, but how do we get that number right?
So the idea is if your long risk assets, which most people are most of the time, one way to hedge that would be to sort of, you know, make big bets on rates coming down sharply. It doesn't mean that that's your main view. It just means that if your your bullish view is going to go wrong, a way to hedge that is to you know, place big bets on rate.
Yeah. Well that's why the curves inverted. But I mean, I think buying tenure rates is kind of silly right now. I mean, if you're gonna go and buy this theoretical insurance policy of the FED doing a massive cut because of a hard landing, you want by the two year rate. And that's why we created another product that's basically at five times levered two year. That way you get the duration of the.
Ten's just a ticker on that. I want to look at that.
Well, t u A to you. So it's a very in theory. Civilians could do it. They can just buy their own futures contracts, but civilians usually don't have futures contracts accounts, so we are off for them for very small fee.
Got it, Oh, t u A, I think I remember this one. I used it to compare the performance of the treasury market to a bitcoin.
Now I want to go look that up. Let's go back to your outlook for the year. So I really do love this sort of thinking. It's like, okay, on his epitaph, on his obituary, Powell may have this sort of like human impulse to not be Arthur Burns two point zero. But you know, there also is the chance for not to just avoid being Arthur Burns, but to deliver the soft landing that every economist has said impossible.
So not just avoiding being one of history's sort of scape goods, but actually being a legend and being the central banker who fought the crisis in twenty twenty and then delivered the soft landing when everyone said it was impossible and that we'd have to have employment go to six percent in order to get inflation down. Like, do you put any weight on this possibility that the sort of FMC goes for the let's be legends outcome?
Oh? Sure, I think they're they're there. They're going to try and do it, and they it may well work. I'm gonna say it's not gonna be six cuts. It'll be two or three and it's not gonna happen in March. It'll happen in July. That's all I'm saying.
So not radically different. Your sort of view of where what the Fed does in twenty twenty four is not radically different than what a lot of pundits are thinking.
Cruggling back to the duration credit convects. The idea duration is I buy it here, it ends up there. Credit I buy it here, it ends up there. It doesn't matter how it gets to the found destination. Convexity is path dependent. It matters how you get there. And so what we're arguing about now is not where we're going to be, but how we get there. And I'm saying that we're gonna get there much slower than the market thinks.
And I want to go and invest accordingly. And if I do that, this is where mortgage bonds come in. I'll say you. If you want to want the big prediction here, it is the Fed once a two percent inflation rate, they'll get it eventually. I presume they're gonna put the funds rate at two and a half over
for a fifty basis point real return. Historically, like if you're a you know, bond geezer like, I am funds rate to two years fifty basis points so now worth three twos tens one hundred basis points so now worth four. So we're kind of looking at the tenure right now. Is what three eighty three ninety four four whatever it is?
I mean, it's done, it's stick a forgative man. The tens aren't moving, and I think the three of yr rate probably goes up from here as the curve re steepens again all the actions the front end that's for all the action is going to be and when it happens. And so the trade that the geeky quants, the complex people, as you might say, are yelling about right now is how do I go and bet on a yield curved steepening. That's very tricky to do. Fortunately, I do have products that we'll do that.
Also, Wait, don't you just do a steepener tart? Like how what are you recommending here?
Oh? Sure, a steepid exactly what you do. But who can do that? I go shure, you people on this podcast can't do that.
Yeah, well we can't do anything because we work at Bloomberg.
To be clear, if you bought my pifix ETF that trade actually will make a lot of money if the yield kurt steepens as I've described it, which is the ten you're not moving, the two you're coming down, the thirty year going up. That'll be a very profitable trade if that happens, And the cost of holding that trade is rather slim for a variety of reasons that don't matter.
You know. One of the other things that happened in twenty twenty three and twenty twenty two, and one of the reasons it was so painful for a lot of investors was bonds and stocks became positively correlated. Right, Everything sold off all at once, and this was bad news for anyone who had constructed a sixty to forty portfolio, or who had bought bonds as a hedge for riskier assets. How are you viewing that relationship going into twenty twenty four.
I think there's still an assumption that things are sort of moving together. But could we get a situation where maybe they become invert correlated again.
If you were reading my covecs they maven commentaries long enough to notice the colors I have there, you would notice that quite a number of years ago, I was talking about this exact notion of the correlation of stocks to bonds, and what you saw was prior to ninety eight, ninety nine to two thousand, you saw stocks and bonds go up and down together. And for the last twenty years they went inverse. They were hedging each other. Yeah,
and now they're back to being positive correlated again. The driver of that has been the level of interest rates. And if you go to my website, I have a number of charts that show exactly this, that when inflations blow two and a half and tenure rates are below three and a half, you tend to see them work in oppsit directions. When they're above that, they work in the same direction. So I think you're gonna see stocks and bonds correlated until we get rates and inflation back down again.
I love that. I mean, there's like an intuition if inflation is low, fed is more on fed put mode, et cetera. You sort of get those like buoyancy under equities. I want to go back to the idea of the steepener and right now, if you just were to put on it, make a chart, a dual life access chart, or I guess even one you know, two year ten
year yields, they kind of look the same. But as you point out, and as people have been discussed, you could get to this point eventually or the FED cuts and that is viewed as reflationary or you know, creates this positive impulse and you could have the decline at the short end and then the long end is the
rates go up? When does that happen? At what point? Like, we haven't seen it yet, right, So we've had these expectations of cuts, this pricing end of short end cuts, and we've seen the long end go right down along with it as the two year fell. At what point does that change such that the expectation of cuts in the short term leads to higher rates of the long term.
Well, there is the expression of don't fight the Fed, and the reason is they're bigger than you are, man, They're the casino. The FED will cut rates. Yeah, I'm not sure when I think July, but they will cut rates, and as they eventually start to cut rates, the curve will steepen out. The question is how much of this steepening will be the two year coming down versus a
rotation of twos down in tens and thirties up. I tend to think it'll be a rotation for the reasons you've described when's going to happen.
It's fun they cut, So right now we have markets sort of coming down with the pricing and of cuts, but you're saying when they're actually realized cuts is when we would start to see that relationship change.
Tracy was talking about this notion of the curve predicting the economy, and it's predicted the last I guess eight recessions. It's been spought on for forty years. We us here always talk twos tens because it's kind of fun. The actual research was the three month rate versus the ten year rate in treasuries, not in swaps, and the three
month rate is the FED rate. The market can't go and pull the three month down with the FED rate up where it is, so you need the actual Fed to cut the interest rates to go and pull the three month versus ten years down, and that's what will happen. And all that's happening right now is people are in theory placing these bets on when this will occur. I think they're over their skis on this, but you know, we'll see.
I just have a couple more questions, but one of them is slightly outside the world of fixed income. But I think given your experience in derivatives and you know things where the tail is sometimes wagging the dog, maybe you have an opinion on this. But zero day options, is that something you've been following at all in the stock market.
I find them very interesting and they're important to the extent of when these options are trading, there's a buyer, there's a seller. It's a closed system. The world has not gone more or less optional or convex. It's a
closed system. However, the two parties may act differently. So once upon time when you would see huge options selling in the bond market or option trading, that might reduce volatility because the seller very often would be my ex employer and they would not be adjusting their portfolio, whereas the buyers, people like me when I was a trader on Wall Street, I would be delta hedging, adjusting my portfolio. And if I'm trading against the option but the seller isn't,
that'll drive the market towards the strike at xpery. The question is now, is those zero day options are the buyers. Are the sellers trading them? Are they adjusting them? And is that I'm gonna guess their retails by selling the options. But in games Stop they're buying it. And so what you saw there was Game Stop they buy the option, sit elt Sasquahana would sell the option they were hedging. Retail wasn't. And that's what drove the market to be
more volatile. Right now, you probably retail selling the options. It s tis Quanta retail buying it, and therefore that's reducing volatility. So you got to figure out who's the buyer, who's the seller, who's trading it, and who's not. Can we know that I see these guys on Wall Street all the time saying, you know, this is the net Gama of the world. Like do I believe them? Not? Really? It just sells newspapers.
Can I just go a quick question? And I'm asking you this because you mentioned a handful of tickers that your firms Simplify Asset Management has created, like prefix. Are these instruments that at different times you would recommend go long or short? I mean, so you have this desk where you can convert institutional quality trading of futures and swaps, et cetera into a retail package that one could buy
even on a platform like Robinhood. You know, and when I think of asset management in general, you know, I think of like basically managers who want to create products that will go up. But is the idea here that you want to create products that allow people to have exposure in both directions.
Some of our products are more strategic, some are more permanent. One could argue that that Pifix was strategic. You know, it came on two years ago, riach, we're you know, one two percent, and they went a lot highers that worked. I might add, though, although they desire to buy this product, is less now because clearly we're kind of this, you know, great paradigm of flat to low. I'd argue that it still makes sense to own it, maybe less of it.
Because you don't buy insurance because you think you're going to crash. It's because you might be wrong and you might do it. You don't buy pifix because you're embarrassed on rates. You buy it because your bullshy might be wrong. And so as an insurance policy, a very low cost insurance policy that makes sense. MTBA, which is our mortgage product. That's more of a lifetime product. I mean that yields one hundred and fifty over the curvature. You will always
have exposure in the mortgage market. If you are in fixed income, you'll have some amount of money there. You should have a lot of it now in the mortgage market, and after the curve steepens involves come down, you should have less of it. Yeah.
The p fix chart looks fantastic if you got in in twenty twenty one and got out sort of like last year. Yeah, but uh, feller's extremely painful if you got in just before the end of the year.
We've had a huge thirty four dollars distribution.
Oh is that what it is? This is my fault. I should adjusted for distributions.
So you still didn't want to get it in October thirty first, No, the line is distorted at the end by that distribution.
Yeah, since the distribution is the product has been re restructured to the very similar to what it was its original entry points two and a half years ago.
So it's you kind of have to reload.
You're supposed to reload now. It's actually a little better product now than before. Although clearly, you know from one fourteen down to forty looks challenging, but remember thirty five bucks of that is distribution.
I just have one more question. It is the most important question.
Are you going to steal my question of this conversation question?
Oh yeah, Joe, still one of my questions. I don't think I am okay good, But you can claim that I have and then show me the evidence. But this is very important. What's your favorite color? Was that your question was?
It was close? So I'm just gonn we just can Yeah, you could tweak it, just like answer the question. So for those who have never read Harley's notes, you know here in Bloomberg we have the gold line sometimes in a white line. I sort of leave it at that. Harley these notes, I'd see. I'm looking at the most recent grabag. There's the Kiddorooki line which I had, Zimbibu line,
the kahaweel line, and these are apparently all colors. So I was like chatting with Tracy's like do you like go down through like the pantone catalog each time to come up with new catalog? Like what are these colors? And I guess, like what is your favorite but how did you or what is all this sol about?
I started writing a commentary nearly twenty years ago. You can go to convexdemaven dot com. That's my entire inventory of commentaries. I published every six to eight weeks. It's free, semi email the list. I'll talk about macro concepts. I started doing colors because I hated the all the charts of Marylynch. We're all various shades of bling it out.
Of that sort of like the strict cell side like styled guides for.
We had just created this new charting system that allowed you to actually pick all the colors available. So I started doing that just to get attention. And then after a while I started naming the colors. That was fun, that was crazy to do. And then after about you know, fifteen years for colors, so I started going to actually now foreign languages is the trick.
Oh, got it?
But my favorite color that was when I used hemoglobin for red like that.
Have you considered starting your own line of paints inspired by your chart colors, because I have to say, aspergen is a very few color that I would consider for a kitchen something like that.
Someday.
All right, a new area of diversification. Harley Basman, that was an absolute pleasure. I'm so glad we finally had you on the podcast. We wanted to have you on for a very long time and this was the perfect time to do it. So thank you so much. Thank you, Joe. That was really fun. I'm glad we finally had Harley on. I'm glad we got him to explain convexity to us, given that a lot of his trade ideas for twenty twenty four seem to be all about convexity.
Yeah.
No, that was a lot of fun. And I really appreciate the balance of sort of big picture macro thinking about like, you know, the sort of the reputational impulses for the FED, the sources of inflation going forward, so these big picture macro things, and then how one goes about connecting that or, as they say in the expressing that in the form of like very specific trades. Was really interesting to hear us thinking on that.
Yeah, and this is really what I think differentiates Harley's
work from some others on Wall Street. It's the attention paid to the construction of the trade and the technicals and how exactly you're expressing a particular view because very often, and you know on this podcast included, you will have people coming on who say like sell credit, yeah, or buy credit or whatever, but they don't actually go into how one can or should do that, and it makes such a huge difference to returns and investors ultimately, and
to get back to the sort of zero day option question, it can have an impact on the overall market as well, like the way these popular trades are actually constructed.
Yeah, and as you've been talking about for a long time, like really large scale portfolio managers, like it's not like stocks now just in like, you know, even something simple about like expressing a view on rates. If you're bullish, you buy stocks, right, I mean some people may, right, but you know, even if you have some sort of view on rates, like you know, these big names that you know, like Pimco's of the world, like this is
what they are doing. They're coming up with different ways of expressing this that is not maybe as sort of straightforward as their peers on the equity side.
Absolutely, there is a whole hidden and wonderful world of total return swaps, index options or swaptions, lots of stuff that just doesn't get as much airtime totally. All right, shall we leave it there?
Let's leave it.
There has been another episode of the Oddlots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
I'm Jill Wisenthal. You can follow me at the Stalwart. Follow our guest Harley Bassman, He's at the Convexity Maven. Also go to his website, check out his writings, send him an email, get on his list. See all the different colors he uses for charts. Follow our producers Carmen Rodriguez at Carmen Arman, Dashel Bennett at Dashbot and Kelbrooks at Kelbrooks. And thank you to our producer Moses Ondam.
From our Oddlows content. Go to Bloomberg dot com slash odd Lots, where we have a blog, transcripts of all our episodes, and a newsletter, and you can talk about this episode, along with any other twenty four seven in the chatroom Discord Discord dot gg slash Oddlaws.
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