What Bessent Is Really Doing in the Bond Market | Mike Green

Michael Green (0:00)

This is a very dangerous wound and situation that we have.

You need to take this very seriously. The Treasury is going to be forced to address this. This is just debt management, and it makes perfect sense. It's exactly what you should do. Scott is sitting there with the tourniquet saying, do you want me to put it on or not?

Maggie Lake (0:22)

Hello and welcome to Wealthion and Maggie Lake. Joining me today to discuss the outlook for bonds and what it means for your portfolio is Michael Green, CEO and CIO of the newly formed Tier 1 Alpha Asset Management. Hey, Mike.

Michael Green (0:35)

Hey, Maggie. It's great to be here. Thank you for having me. Great to have you.

Maggie Lake (0:38)

Congrats on the new venture. This is super exciting.

Michael Green (0:41)

It is exciting. It's an awful lot of work and congratulations is not the appropriate sentiment. Yeah, good luck is a much better sentiment. Once dollars start coming in the door on a sustainable basis, then you can say congratulations.

Maggie Lake (0:55)

All right. Well, we know that's going to happen and it's really interesting, exciting stuff. We're going to talk a little bit more about what you're doing and why now, because it's, I think, a really interesting story. But first, there's a lot happening in market. So let's talk a little bit about what's happening in the bond market. And excited to have you for this conversation, because you and I have been talking throughout the year. You wrote an open letter to Treasury Secretary Scott Bessent earlier this year. You've been vocal about policy and policy decisions and potential paths forward.

In August, Bessent intervened in the Forex market and announced a Treasury buyback plan, which sends a lot of ripples through markets. What's your take on these policy moves?

Michael Green (1:35)

Well, unfortunately, as you and I have talked over and over again about the passive influence on equity markets, unfortunately, what I think we're largely seeing right now is a global phenomenon in which duration is selling off because there is an absence of the marginal buyer of the longer dated bond. I actually don't think that that buyer is missing the way other people do. I think they have simply assumed a different approach to how to manage their portfolios than traditional participants would. If you think about a long dated bond, it would have historically been purchased by somebody like an insurance company that was looking to match assets and liabilities. In that framework, you're looking at the value of that bond relative to the value of your liabilities and matching the two on a duration basis and on a required income basis. Another type of buyer is what's called the levered buyer, right? This is somebody who's going to finance the long end by selling the short end. They will short a three-month Treasury, obtain financing, and then buy a longer end Treasury. The marginal buyer today is actually a passive bond fund, and that passive bond fund ironically doesn't care about any of that. It's simply trying to match its exposure on a notional basis, and this is really critical to the underlying index. And perversely, what that means is when you have an environment like we have today in which there was roughly a decade of very low interest rate, very low coupon issuance, and the Federal Reserve then hiked interest rates, we've seen this in the banking system as these bonds are deeply underwater, meaning they are trading well below their face value. Perversely, that means that a passively weighted bond index fund is going to buy them in proportion to their market capitalization. That price times the notional outstanding. And so as that price has fallen, their demand for those bonds has decreased on a relative basis. This creates the perception that nobody wants the bond, but the players at the game are behaving somewhat irrationally. Equity investors will remember this time as roughly around 2016, where we began to refer to the Costanza market, the market that is the opposite of what you thought it should.

Unfortunately, that's now come to bonds, because your largest marginal player at this point looks at a bond that's trading at 150 and says, wow, that's much more attractive than a bond that's trading at 50 That is absolutely absurd. It makes no sense in bond language, but that is the algorithm under which they are programmed and the markets are now playing that out. They see those long dated low coupon bonds, which actually offer a tremendous feature in bondland called convexity, they have positive convexity to the top side, your money can literally double in many of these long dated bonds.