Harley Bassman, The Convexity Maven

It is a 95% fiscal problem. We got 5,000,000,000,000 of income and 7,000,000,000,000 of expenses. Interest is now 1.1, 1,200,000,000,000. 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 40,000,000,000,000 at 5%, right? Once all the older debt, the low coupon debt rolls off, the new debt comes out, We're talking $2,000,000,000,000 in just interest, which blows away defense spending and everything else. This is unsustainable.

Hello. This is Dean Kernut, 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 and the world.

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

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 and P is kind of reversed. It's typically the S and P's got some shock, it leads to flight to safety and duration rallies. And you look at it these days and it's the ten year note, maybe the thirty 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 thirty to forty year veteran, I would say fort

I write a commentary, episodic, whatever I want to write. They're posted on convexitymaven.com. I have my entire archive on there going back, I don't know, over twenty 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 in a $2,000,000,000,000 deficit with a 4.

Let's drill down into the breakdown of nominal yields into their real and inflation components. And, yeah, TIPS, you know a ton about this market. I know a little bit about it. It's got its vagaries. It's got that illiquidity behavior, especially during significant risk offs. That embedded premium for inflation risk, I think 2.3 is roughly where tens are in terms of breakevens. That's pretty low. If you sort of look at nominal versus real in terms of taking risk and maybe lending to the government with some embedded, some ways put on inflation or inflation protection, Again, getting away from

If you actually think about it, I've said 2.35 is the implied inflation rate, breakeven inflation rate. Just take the ten year nominal, ten year tip, subtract the two. There you go. That's not quite ripe. It's close enough for government work. It hasn't budged in four years. What's wrong with this picture? What's wrong with this picture might be that CPI is cooked. Remember the government rejiggered CPI in the late nineties, Greenspan and Clinton and Rubin and everyone else. And they basically dialed it down with hedonics, asset replacement, like you stop buying beef and you buy chicken, quali

There's a lot of debate around the backup in tens and thirties