Say goodbye to the extremely inverted yield curve, the harbinger of recession that has haunted economic pundits and investors for the better part of two years.
So says Harley Bassman, the long-time bond expert known as Convexity Maven. Bassman — who invented the MOVE Index of Treasury market volatility while working at Merrill Lynch — argues that longer-term rates have already bottomed out as the Federal Reserve nears its 2% inflation target.
The yield on the benchmark 10-year US Treasury currently hovers around 4% after a dramatic 2023 that saw it veer wildly only to end up where it started 12 months ago. Now, the exciting development for bond investors will be moves at the front end of the curve in shorter-maturity debt, Bassman says in a new episode of the Odd Lots podcast.
“It’s done. Stick a fork in it, man. The 10s aren’t moving. And I think the 30-year rate, it probably goes up from here as the curve resteepens again,” he said. “All the action’s the front end, that’s where all the action’s going to be.”
That leaves bond investors potentially scrambling to position for a steepening of the curve after years of flatness and inversion, with the difference between two- and 10-year US Treasuries reaching a low of more than 100 basis points in March of last year. That difference has since shrunk to about 34 basis points.
“You’re going to see when this curve steepens out, which means the two-year rate comes down below the 10-year rate, you’re going to see mortgage bonds in general go up, you'll see mortgage yield come down, you’ll see the retail mortgage rate come down,” Bassman added. “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-curve steepening?”
Bassman, who’s now a managing partner at Simplify Asset Management, is pitching new-issue mortgage bonds to pick up yield without taking on much credit risk. At Simplify, he’s been creating exchange-traded funds that allow retail investors to pursue some of his more esoteric trades, many of which he describes in detailed missives in which he plots his charts in arcane colors such as “hemoglobin” and “bahari.”
The long-time bond investor joins a slew of high-profile names eschewing longer-term debt. Bill Gross, the Pimco founder known as the “Bond King,” predicted the end of the great bull run in bonds in an Odd Lots podcast back in August. Meanwhile, hedge fund manager and prolific tweeter Bill Ackman is said to have made millions betting against 30-year Treasuries last year.
“I think buying 10-year rates is kind of silly right now,” Bassman said. “I mean, if you’re going to go and buy this theoretical insurance policy of the Fed doing a massive cut because of a hard landing, you want to buy the two-year rate.”
Even as the Fed nears its 2% inflation target, however, Bassman sees upside risk in prices. The driving force is vast demographic changes that are increasing demand for goods and services even as interest rates have increased.
“The demographic of these boomers retiring, retiring with a lot more money than their parents had, which means they’re going to keep on spending,” he says. “The old rule was when you got older and you retired, your spending was reduced because you had lower income. The boomers, well, we took all the money. Okay. I am sorry.”
“We took all the money with the stocks, with the bonds, with the housing, with everything else, and so we’re going to keep on spending, but we’re not going to work anymore. So we’re pulling out supply of labor, right? The millennials, they’re working and they’re getting married and they’re having kids. So they have this 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, bought cars.
“So I’m a believer that inflation, the 2% target, is not coming anytime soon. There’s a good story why it might, I’m not a believer in that. And I also think that the Fed is not going to take rates down nearly as much as the market is implying by the futures market.”
Bond traders have been ramping up their bets that the Fed will start cutting interest rates as early as March, with swap contracts referencing Fed meeting dates now indicating that the market expects the policy rate to fall by a quarter percentage point from its current range of 5.25%-5.5%.
Still, Bassman sees reason to be cautious even as he sees the central bank moving to tamp down inflation.
“I think what Jay Powell’s thinking about now is really not inflation per se, but what’s my tombstone gonna say? Is it gonna be Arthur Burns, who basically we all, is the poster child for inflation getting out of hand, or is it going to be Paul Volcker the saint who saved it from inflation?” Bassman says. “He wants to be Volcker, 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, you know, wooden-stake-in-the-heart dead.”