Harley Bassman on Trump, the Fed, and the Bond Market

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1:25Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, the week's not over. Yeah, we're recording this November 6th at 10.33 a.m. But one thing that is over is a lot of people expected that at this point there would be significant ambiguity about who had won the election. And actually that part is over. There's no ambiguity at all. It's been called. Yeah, that's right. So Trump has obviously won the election and we've seen a pretty big market reaction. Equities obviously up, but also bond yields are going up, which means prices are going down.

2:07And there's been lots of talk about the return of volatility in the bond market and the way investors or traders were sort of approaching event risk from this election. I wrote about it in the newsletter. There are other people who have been writing about it. And of course, as I said, the week isn't over yet. We still have that Fed meeting on Thursday. No, that's right. You know, you mentioned the event risk and the stock market rally and the bond move. And I would say two things. I think there is probably just sort of generically probably a view among equity investors that Trump era policies, probably less regulation, lower corporate taxes is good for stocks.

2:48That seems like something. On the other hand, it's interesting because the VIX has absolutely collapsed. And so I think part of the reason perhaps for this at least some component of this stock market reaction is probably just the end of that election certainty being gone. the unambiguous outcome and setting aside Trump versus Harris policies. Now, on the other hand, what's interesting is the move index, which, you know, like the VIX for rates, that's lower, but not dramatically lower. And it still remains at very high levels, at least relative to recent years or at least over the last year. So there are sort of, I would say, competing forces.

3:29You know, some aspects of uncertainty are gone. It's good. But then there, as you say, this sort of march up in rates, which is a global story, by the way, is still a big thing out there. Yes. So we are going to be focusing on bonds today. We might record an equity specific episode later this week. But because of the upcoming Fed meeting and the election this week, we felt, you know, let's look at bonds. Let's look at bonds. All right. And who better to look at bonds than Harley Bassman, managing partner at Simplify Asset Management and the creator of Convexity Maven, which is an awesome publication if you're not already reading it.

4:07Harley, thank you so much for coming back on All Thoughts. Thank you very much. Glad you're awake today. He's also the creator of the Move Index, which I'm in addition to the creator. Oh, yeah. I forgot about that. In addition to being the Convexity Maven himself. Anyway, keep going, Tracy. Well, OK, why don't we start with the move index then? Harley, explain or just give us a recap on what's been going on with the move, because there was one specific day where we saw a big move upwards. Ha ha ha in the move. The move is the Vix for bonds. It's basically a one month window. And so last month, when we went from October 4 to October 7, the election popped into that window.

4:50And so that's when you had the big jump in the move. And from that, you could then calculate the market's expectation of volatility from that. And when it crossed over a month ago, I said 18 basis points. When we walked into yesterday, it was at 17 basis points. So the market kind of got it right. And as I look at the screen right now, 10-year rates moved about 18. So market kind of called this thing right on. The move was at 130-ish. It's now at 117-ish. It's going to drop again after the Fed on Thursday, because we still have the uncertainty of what they're going to go and do. We kind of think it's locked in, but not for sure.

5:27And you'll see the move kind of drop down after that. I guess the contrast you're kind of zipping towards is that the VIX at 15-ish now, it never got that high. It got to like 20-ish two days ago, which is barely above its long-term average. Stock market has not moved that much for this entire time. all the volatility has been in rates, the uncertainty of what the Fed's going to go and do. And that still is not over. We still have to figure out what is the terminal value, the terminal rate that that's going to get to, as well as where we're going to be this December, which is very interesting right now.

6:04If you look at the market, we've had the market pricing in a lower rate than the dots, the Fed's prediction of policy going forward. That is now flipped over. We now have the market at 40 basis points higher than the Fed's most recent dot plot. And that's kind of new. So the market's kind of changing sentiment here about where we're going to land a December from now and then two years from now. Is that rare historically that here we have the VIX really close to rock bottom levels and the move is still somewhat elevated? If you go back historically, is this common in periods? Because intuitively, I would guess that if there's a high amount of uncertainty about what the Fed is going to do over the medium term, I thought, you know, things like inflation in the Fed mattered for stocks.

6:52And therefore, on some level, that would translate to equity markets. How rare is that disconnect? In general, from 30 ,000 feet, the move and the VIX go hand in hand. You can't trade them. Don't ever do that. OK. But they generally go hand in hand. And as far as I can tell, this is the longest period of where there's been a disconnect between the two of them, which is not really a shock when you think about it, because all the uncertainty has been in the bond market. We had QE, we had QT, we had ZERP, we've had the Fed taking rates of 500 points in short order. The uncertainty has all been in the rates market and not in the stock market.

7:32And for reasons for that, the fiscal impulse of spending money has kept the stock market and the economy going well better than expected. So it's surprising, but when you look at the actual data, it's not that much of a shock. We still don't know where rates are going to settle, but we have a pretty good idea the stocks are going to be okay. So one thing I've been wondering is you often hear from Republicans that they think economic growth will offset things that increase the deficit. So we can have big tax cuts because the economy is going to boom. And so the U.S. will get more income and that will ultimately help offset the deficit.

8:09I'm always curious from a bond trader's perspective, how do you actually incorporate economic growth specifically into your outlook for rates? That's a challenge. I mean, we have the numbers, but long and variable lags, as the expression goes, tends to dominate. I'm UChicago. I'm a monetarist. I think printing money causes inflation, just takes time for it to happen. I mean, what you've seen recently is the Fed basically printed, created lots of money. And in the last four years, they set that pile of money ablaze. And here we go. We have higher rates, we have inflation, and you have a stock market doing okay.

8:49And it seems like that's not going to change. Going forward, it becomes very interesting. The market's moved to where it's supposed to go to. I think we're at fair value right now. Now, you can go well above fair value, But we've kind of gotten to where we're supposed to go if you kind of take the Fed at its word of where their inflation is going to be and where the economy is going to be. What we don't know right now is the push me, pull me effect between the fiscal impulse of theory that Trump's kind of advertised spending$7 trillion more versus immigration policy and tariffs, which are negative.

9:22How is it going to work? That's unclear. I mean, which side is going to go and win? This is kind of why we have to go and really kind of, the expression has been, you take Trump seriously, but not literally. I'll go with that. We don't know what he's actually going to do at the end of the day. Is he going to deport 10 million people? Kind of doubt it. But could he go and deport a million? I guess so. And will that be impactful? Yeah. Yeah. I mean, is he going to raise tariffs? He's going to triple tariffs? No. Could he take about 20, 30 %? Yeah. And what will that be through the system? We don't know yet.

9:57Right. And I think there's just a tremendous amount of uncertainty on the specifics of this point. And obviously something we're going to be covering a lot, really, I think, in the years ahead, trying to understand how the economy evolves. Let's take it really short term for a second, because we do have that Fed decision tomorrow. It seems like the market's basically locked. It's going to be a 25 basis point cut. Is there anything that you'll be watching? You know, there's no dots that are going to come out tomorrow. So it's I don't know, maybe especially in the context of this week, one of the least anticipated Fed decisions I can remember in some time.

10:34But there's always some signal. Is there anything in particular that you'll be watching or listening for tomorrow when that decision comes out? I've been saying for many, many months now, I mean, I am hired for longer. I will say that I was on the record thinking they would not cut last time. I thought they'd wait till after the election to go and do it. But I still think we have to go and focus on what's really important here. The reason why we still read the Greek tragedies, we still read Shakespeare, is these guys captured the essence of mankind, which is hubris, ego. Jay Powell does not want to go down as Arthur Burns, who cut rates as inflation came down in the 70s, and then inflation came roaring on back, and he became the dog of inflation, whereas Volcker is our saint.

11:17I think Powell wants to go out as the hero. And therefore, with what's going on and the proposed policies by Trump, I kind of think he's pretty worried about a resurgence of inflation and having his tombstone say, Arthur Burns redux. So I kind of think he's going to want to go and sit back a little bit and kind of watch and see what Trump actually does. I just don't see him dropping rates as hard as everyone thinks if he thinks he's going to go and reignite inflation and damage his legacy. I think his legacy probably matters more than anything else to him. Yeah. One thing I wanted to ask you about, you know, you mentioned that idea of taking Trump seriously, but not literally, and how that introduces a lot of uncertainty in the market.

12:00Some of that uncertainty, in addition to being captured in the move index, has been captured in the term premium, which has been going up. And term premium, I mean, everyone has different definitions of it. but a basic one is that it is the extra compensation or yield that investors demand to hold longer-term debt. And the thinking here is that the term premium might be going up because we're going to have all that uncertainty that comes with a Trump win. How are you thinking about the term premium from here on out? I'm thinking about what is what's called fair value, which is almost a meaningless number.

12:38But what's fair value? Let's just say inflation comes in at 2.5 % as opposed to 2%, which is not a shock. PCE is 2.7%. The Fed slaps on 30, 40 basis points of real rate, right? And then you go in and put on the proper curve. And historically, going back 35 years, including all the stuff up and down, all the various panics and QEs, basically, you averaged 150 basis points, 140, 70 to be precise, between Fed funds and the 10-year. Well, the Fed funds is going to be 288, which is the long-term dots we have right now, which is 38 basis points above inflation of 2.5, so a real rate of almost a half point there.

13:16That puts 10s at 435. We're 445. We're kind of there right now. What I see happening is the Fed will take rates down slower than expected. In the 10 years, we're kind of in the kill zone right now unless something crazy happens. and we have nominal GDP coming in like at five-ish, okay. I mean, nominal GDP should kind of equal 10-year rates in the grand scheme of the world as a UChicago person. And so I kind of think the term premium, as we calculate it, will expand as the front end comes down and we'll all be right with the world, except for a few bumps and bruises along the way. Once again, we really don't know what's going to happen between immigration and tariffs.

13:59And immigration, I don't want to get hung up on the politics of it. But I want to be very clear, at the upper level, the economy is people times hours times productivity. People, hours, productivity. I think what's happened in the last two years is we've had more people come in via immigration, legal or otherwise. That supported the economy. Thus, we have numbers coming in better. And then if we start deporting people, you'll have less people. You'll have less GDP. Is that bad? Maybe not. But I mean, if that's how you view the world, you want to reduce immigration, if you're willing to go pay a higher interest rate for it, that's fine.

14:39I'm not going to debate the concept. I'm just going to say what happens at the end of the road when you do that. And we're always willing to go and make cost-benefit payoffs when we make decisions. Nothing's free in the world. So, green policy, if you want to transfer from oil to solar and wind, right now it costs more money to do that. I'm not saying it's a bad policy, but we're willing to go pay it to go get that climate under control. That's OK. Just remember, you're paying a price for it. And what price are you willing to pay?

15:25Your best restaurant location gets five-star reviews. How do you make every location like your best location? Your best paper mill has been operating at peak productivity. How do you make every mill like your best mill? Your best data center has optimized every drop of water. How do you make every data center like your best data center? The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. How many vendors does it take to meet all your organization's food needs? Just one. EasyCater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor.

16:11In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. You mentioned Powell and the ghost of Arthur Burns, which of course is something that people have talked about a fair amount. He doesn't want to go down as the person who really let inflation run wild again. And, you know, earlier this year, it seemed like, okay, that had been cemented.

16:48They did the 50 basis point cut. Since then, the economy has been a little stronger than perhaps people had expected. Then there's all the Trump uncertainty, etc. That being said, this gets to taking Trump seriously versus literally and the uncertainty about what we don't know what he's going to do. One thing we do know that he did last time was browbeat Jay Powell on Twitter and other platforms about lowering rates. When you think about that time period, specifically 2018, 2019, I think it was more 18. Did that have an effect? And should we think about the pressure that would probably likely emerge in 2025 again if there's not significant rate cuts?

17:27I suppose, but I think the much bigger event around that time was that when Powell's time came up for renomination, the government dragged their feet by like nine months on that because there was so much, you know, I guess because Biden wanted to put in a more dovish person. But in 2018 specifically, that's when Powell was still hiking rates. We got the far away from neutral comment, which eventually had to get reversed. And that was when Trump was doing a lot of tweeting about rates. And so there was that pressure from the White House to the nominally independent Federal Reserve or the independent Federal Reserve.

18:04And what I'm curious is whether you think, as you recall back at that time, that that pressure had, at least at the margin, some effect on the policy setting. I don't think it had that much. And I don't because now we've had another, you know, four or five, eight years to look at this thing. It's unclear to me that what Trump was saying in Twitter was the same thing he was saying, you know, via Treasury secretary. It seems to me that there's a there's a dual level over here of what he actually wants to do versus what he says. using the bully pulpit. So it could be, it could have been, let's say he's telling Powell to keep going to keep everything constant.

18:40But in public, he's saying, take them down to go and, you know, sound good. Root for the home team. It's unclear to me if that wasn't the case. Joe had a great piece in our new daily newsletter last week, or maybe it was two weeks ago. I think it was two weeks ago. I know we've lost all track of time. Yeah. Time is a flat circle at this point. But it was about potential constraints on Trump that are introduced from the rate market. So, for instance, we know that mortgage rates broadly track U.S. Treasury yields. And so those have been going up recently. And most people don't like it when mortgage rates go up.

19:16Are there any political complexities that are introduced for Trump from the rate market? The sort of real world impact of the rate market? I think the real world is going to have to be real money, which means the rates go up and therefore the deficit goes up because our interest payments go up because we have so much of our debt is front loaded that keeps rolling over. So, you know, it's not like we put out so much 10 year, 30 year paper where the rates locked in. We have most of the debt in the front end. So if rates go up by 100, that almost immediately goes into deficit spending. I think those kinds of things where the real money hits the road could be a bumper for how he operates.

19:57I don't think the actual rate moving itself will be the cause. I think we have to see the whites of their eyes for it to happen. I just have one more question, I think. But, you know, you mentioned the sort of multiple messages from the last Trump administration. And he may have on Twitter been browbeating Powell about lowering rates. But I think his Treasury Secretary, Steve Mnuchin, operated as what I would say is like a fairly normie Treasury Secretary. Not a lot of populism, policy, adventurism, etc. Seemed to actually, in retrospect, at the time, but also in retrospect, have a fair degree of respect among people, I would say, on both sides of the aisle.

20:39In the weeks ahead, how much are you going to be keying on to personnel decisions when you're thinking about the medium term or longer term trajectory of this stuff that the new administration makes in terms of how that will feed through into things that would affect interest rates? I think you have stumbled over the truth. I think who he picks for his cabinet and his senior leadership team is almost vastly more important than Trump himself. We saw who he picked last time. Very seasoned, I won't say establishment people, but seasoned people who knew the game. To the extent he brings in less seasoned people, that brings in uncertainty.

21:18It doesn't mean it's bad. It just means it's uncertain. Markets hate uncertainty. So I think we're going to still see a lot of volatility in the market until we see the slate of who he's going to bring in for the key positions. All right. Harley Bassman of Convexity Maven, the Convexity Maven. And thank you so much for coming on OddLots at short notice to talk about the bond market. Thanks. Thank you.

21:53Joe, Harley is great. And I think he was truly the perfect guest for this particular conversation. One thing I'm wondering, how many times do you think we said uncertainty in that podcast? We'll have to go back to the transcript and look. No, he was because, look, it's the Wednesday morning after the election. And there are so many questions and so much time and space for sort of big picture future of the country, future of the Democratic Party, all these thoughts. And it's like, I'm not really into trying to figure that stuff out less than, you know, 12 hours after we got the result. So Harley was great because then, of course, we have this Fed decision.

22:31And so a nice stop, a nice little snapshot of this moment in politics, economics and rate market uncertainty. I do think, though, when it comes to rates, the move upwards that we've seen recently, there was discussion about whether or not they were moving in line with Trump's chances of winning or signs that the economy was still going relatively strong and that might imperil the Fed cuts. But I think maybe that argument is settled somewhat today with that reaction, because we pretty much know that the Fed's going to cut tomorrow. and still rates are moving up. So at least that's one thing, I think, that's been kind of settled.

23:17Yeah. Yeah. I'm not totally settled. But there are, look, I think - I'm, yeah, maybe I'm clutching at straws at this point. We're looking for something real. You know, I would just go back to two things, which is it is interesting, as Harley confirmed, this disconnect between stock volatility and rates volatility. And it'll be interesting to see how long this gap persists. And then the other thing I would say is, you know, we talk a lot about bond market vigilantes. And I've never loved that term because I think it prescribes a certain level of agency to individual investors that I don't think is necessarily warranted.

23:54But two things. To your point, I still think people really don't like higher mortgage rates. And I think this is going to be a on some level political challenge for the Trump administration. And B, even though we didn't really talk about equities very much, people like higher stock prices. 61 % of American households, according to Gallup, own stock. Stock is how people fund college education. Stock is how people fund retirement. And one thing that I'll be curious about is what I would call the stock market vigilantes and the degree to which equity markets act as a constraint on policy adventures, and particularly on things like tariffs, et cetera, that you could imagine a lot of companies in the U.S.

24:36really won't like for various reasons. I just think like financial market vigilantes in general, I think it'll be really interesting to see what kind of limit they impose on a Trump administration that may be stocked with potentially different type of personnel than the first one. Well, I guess the only uncertainty at this point is that we will have lots to talk about. Yes. For sure. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. I'm Joe Weisenthal. You can follow me at The Stalwart.

25:09Follow our guest, Harley Bassman. He's at ConvexityMaven. Follow our producers, Carmen Rodriguez at CarmenArmond, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks. Thank you to our producer, Moses Andam. For more OddLots content, go to Bloomberg.com slash OddLots, where we have transcripts, a blog, and a newsletter. And you can chat about all of these topics 24-7 in our Discord, discord.gg slash oddlots. And if you enjoy Oddlots, if you like it when we look at the bond market with veterans like Harley Baspin, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, in addition to getting our new daily newsletter, you can also listen to all the Oddlots episodes absolutely ad-free.