Harley Bassman MM
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Podcast Summary
In this episode of Monetary Matters, host Jack Farley interviews Harley Bassman, managing partner at Simplify Asset Management and known as the "Convexity Maven." (00:51) Bassman argues that inflation will remain structurally higher at around 3%, driven by demographic shifts as baby boomers retire and spend their wealth while millennials enter household formation. (03:27) He predicts the 10-year treasury will reach 4.35% as massive fiscal deficits continue to pressure bond markets, while passive 401k flows support equity markets until unemployment reaches 5%. (05:12) The conversation explores sophisticated bond trades including mortgage-backed securities, ultra-long dated options for portfolio hedging, and alternative investments like BDCs, MLPs, and gold as protection against fiat currency debasement.
- Main themes: Structural inflation persistence, bond market opportunities through convexity trades, and portfolio construction using leveraged instruments and alternative currencies
Speakers
Harley Bassman
Managing partner at Simplify Asset Management and widely known as the "Convexity Maven." Bassman has extensive experience in bond trading, having worked at Merrill Lynch's government bond trading desk where he worried about job security during the late 1990s budget surplus. He is a University of Chicago graduate who follows Milton Friedman's economic principles and specializes in creating sophisticated derivative products for retail investors through ETF structures.
Key Takeaways
Inflation Will Remain Structurally Higher
Bassman argues that inflation will stay around 3% rather than returning to the Fed's 2% target, driven by three key demographic and policy factors. (01:55) Baby boomers are retiring with significant wealth and will spend more than previous generations, while millennials are entering prime household formation years with delayed marriage and childbearing creating pent-up demand. Additionally, any reduction in immigration will decrease GDP growth since "GDP is people times hours times productivity." The fiscal deficit of 6.5% during near-full employment without wartime conditions adds further inflationary pressure. This structural shift means investors should position for a higher inflation environment rather than expecting a return to the low-inflation regime of the 2010s.
Mortgage-Backed Securities Offer Superior Risk-Adjusted Returns
Newly issued mortgage-backed securities provide compelling value compared to other fixed income alternatives, offering yields around 100 basis points over treasuries with zero credit risk. (17:29) These government-guaranteed Fannie and Freddie bonds trade like covered calls on treasuries, providing higher income in stable rate environments while limiting upside in major rate rallies. The key advantage is focusing on newly issued MBS trading near par with 5%+ coupons and 4-5 year effective duration, versus older low-coupon bonds from 2020-2022 that behave like 10-year securities. This structure provides 50% less volatility than the broader MBS index while delivering similar returns, making them ideal for conservative portfolio allocation.
Ultra-Long Dated Options Provide Capital-Efficient Hedging
Seven-year options on treasury futures offer unprecedented capital efficiency for both bullish and bearish bond positions through extreme duration exposure. (23:37) The interest rate hedge provides negative 40 duration, meaning it gains 40% for every 100 basis point rise in rates, while the bond bull offers massive positive convexity for rate declines. These instruments currently provide positive carry due to the inverted yield curve structure, earning 3-4% annually while option decay proceeds slowly given the square root of time relationship. Bassman emphasizes these are insurance products - you buy car insurance not expecting to crash, but to drive with confidence. Similarly, these hedges allow investors to maintain other positions while protecting against extreme rate moves.
Leverage Becomes Attractive as Curves Steepen
As the Fed cuts short-term rates while long-term rates remain elevated, leveraged strategies in BDCs, mortgage REITs, and other front-end borrowers become increasingly attractive. (40:40) High-quality business development companies are trading 15% below book value due to concerns about private credit marking, while their borrowing costs will decline with Fed cuts. This creates opportunity to buy first-lien senior debt exposure at discounted prices with improving funding costs. Similarly, mortgage REITs trading above book value reflect anticipated curve steepening benefits. The key is focusing on quality - first-lien, top-of-capital-structure lending rather than reaching for yield in subordinated positions.
Gold Functions as Alternative Currency, Not Investment Asset
Gold should be viewed as an alternative currency rather than a traditional investment, providing protection against fiat currency debasement from ongoing fiscal deficits. (55:03) Unlike Buffett's criticism that gold produces nothing, Bassman argues this misses the point - gold is money, not an asset. With the US running unsustainable deficits, the only realistic solutions are default (unlikely) or inflation (the chosen path). Central bank buying, geopolitical tensions, and currency debasement concerns support a 5-10% allocation. Gold's historical stability as "an ounce buys a fine man's suit" across millennia demonstrates its currency function. The recent acceleration in gold prices represents years of gradual currency debasement happening quickly.
Statistics & Facts
- The US is running a 6.5% fiscal deficit during a time of almost full employment without being at war, which Bassman calls "utterly insane." (03:57) This level of deficit spending is unprecedented outside of crisis periods and continues to fuel inflationary pressures in the economy.
- The average age of first childbirth is 31 in New York City and 32 in San Francisco, indicating delayed household formation that is now catching up to trend. (02:22) This demographic shift supports continued spending and housing demand from millennials entering their prime earning years.
- Implied volatility on long-dated options has declined substantially, with the MOVE index dropping from 120-140 a year ago to the 70s currently. (30:37) This compression makes both the interest rate hedge and bond bull products more attractively priced for new investors.
