Harley Bassman, The Convexity Maven

Harley Bassman (0:00)

It is a 95% fiscal problem. We got 5 trillion of income and 7 trillion of expenses. Interest is now 1.1, 1.2 trillion. They're taking everything to the front end, right? They're issuing bills and buying back bonds.

Kind of a clever idea that didn't work. If you were to go play this game long enough, and we stay here, and you mark 40 trillion and 5%, right, once all the older debt, the low coupon debt rolls off, the new debt comes out, we're talking 2 trillion dollars in just interest, which blows away defense spending and everything else. This is unsustainable.

Dean Curnutt (0:39)

Hello, this is Dean Curnutt, and welcome to The Alpha Exchange, where we explore topics in financial markets associated with managing risk, generating return, and the deployment of capital in the alternative investment industry.

I'm joined by the Maven of Convexity himself, Harley Bassman, at a time when rates are backing up and Harley's move index is north of 100 Harley, it's great to have you back on the podcast at a really interesting time for markets in the world.

Harley Bassman (1:12)

Thank you. Great to be back. I wish there was a tad more board, truth be told.

Dean Curnutt (1:16)

So much going on, and I'll just start with an assertion that is kind of obvious, which is the causality of moves between the, let's say, rates market and the S&P is kind of reversed. It's typically the S&P's got some shock. It leads to a flight to safety and duration rallies. And you look at it these days, and it's the 10 year note, maybe the 30 year, those to me seem to be the risk assets driving the equity market. So those correlations are really positive right now.

It seems pretty fragile. I just love to start with your take. You're a 30 to 40 year veteran, I would say 40 year veteran in rates and mortgages and analysis of risk. Take us through your big picture of where we are here with, especially with the backup in long end yields.

Harley Bassman (2:09)

I write a commentary, episodic, wherever I want to write. They're posted on convexitymaven.com. I have my entire archive on there going back, I don't know, over 20 years.

It's free, send me an email, I'll add you to my list. And my last commentary was entitled, In Fed We Trust.

And what I'm proposing there is, we don't have an inflation problem with rates going higher. We have a trust problem. We don't trust the government. We don't trust our institutions. Fed, we kind of trust maybe, but away from that, there's no control of our fiscal policy. We're running a $2 trillion deficit with a 4-2 unemployment rate. S&P near its high. We're not at war. Well, I guess maybe we have skirmish right now, but it's unprecedented to have a 6% fiscal deficit without being at war or being in a recession. And for the foreseeable future, it's going to keep on going. Are we going to go bankrupt? No, we're not going to go bankrupt. We issue dollars and we print dollars. We can't go bankrupt. We can't default.

Can we devalue that currency?

Dean Curnutt (3:16)

Yeah.

Harley Bassman (3:17)

I think what's happening here right now is we're just seeing a lack of trust locally and globally in the US dollar. Now, by the way, Western Europe is not much better. Japan clearly is not better. So I guess all paper currency is getting devalued. And how do you know it's not inflation that's driving this thing? If you look at the break-even tips. Now, I'm not a fan of tips, I'll tell you that. It's a small market, kind of controlled by a few people.

Nonetheless, it's been hovering at a 235 breakeven rate for the last four years. We've had rates down and up, and it's been up and down at 235 So the market is not pricing in a big inflation. And core is that to and change, it's not getting away from us, but rates are up 150 basis points in the last X number of months. This is a trust problem in the US.

Why are stocks not breaking? It's not stock in the US government, or in a dollar, or currency. 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. If you bought stocks in high-mart Germany, remember the guys with the real barrels?

If you bought those stocks and held them all the way through, you were fine, because they has raised their prices along with everything else. And their business is expanded. It sounds crazy, but that's what happened over there. And what we're seeing now, I like gold, I like real estate, I suppose, but the idea of the US currency is suspect and we're pushing it back. In a nutshell, the big idea is, how do we get out of this problem?