Harley Bassman: Bonds Are Fully Cooked Without an Imminent Recession
Oct 1, 2024
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Harley Bassman, managing partner at Simplify Asset Management, dives into the intricacies of the bond market. He argues that bonds are 'fully cooked' without a recession on the horizon. Bassman shares his top trading strategies, emphasizing selling interest rate volatility and leveraging agency MBS. He discusses navigating mortgage bonds, the impact of Fed policies, and the importance of risk management in credit markets. Listeners gain insights into the dynamics of interest rates and the essential role of diversification in investment strategies.
Harley Bassman emphasizes that without an imminent recession, the bond market is fully cooked, necessitating strategic trading adjustments.
Selling interest rate volatility, particularly through current coupon MBS and callable bonds, offers better value amid high implied volatility.
Projections suggest long-term interest rates are unlikely to dip below 4% owing to persistent inflation and market structuring dynamics.
Deep dives
Interest Rate Perspectives and Opportunities
The recent decision by the Federal Reserve to cut interest rates has led to reflections on the current landscape of interest rates and opportunities in the market. The back end of the yield curve, particularly the 10-year and 30-year rates, is perceived to be low and nearing its lower limit. This situation invites strategies such as selling interest rate volatility through instruments like current coupon mortgages and callable bonds, which are said to present better value due to high implied volatility versus realized volatility. With forward rates expected to hold steady, this market action could lead to more adjustments in trading strategies focused on long-duration securities.
Impact of Economic Indicators on Long-Term Rates
Projections regarding the long-term interest rates suggest that expectations of significant decreases may be overstated. The speaker anticipates that while further declines are feasible, rates are unlikely to drop below 4% or 4.5% due to underlying inflation targets that the Federal Reserve seeks to uphold. Historical relationships between Fed Funds rates and longer-term bonds indicate minimal movement directionally. The current economic climate, including inflation and job market factors, suggests a continued upward pressure on yields in the long run.
Financial Instruments – Selling Risk in a Volatile Environment
In the current financial ecosystem, owning current coupon mortgage-backed securities (MBS) is presented as a lucrative investment strategy. These newly issued MBS offer higher yields and are suggested over older, lower coupon assets that do not compensate adequately for their risk. The product designed around these newly issued bonds has gained traction since its launch, reflecting strong performance based on both rate movements and spread dynamics. By focusing on selling optionality within this particular market segment, investors can realize improved returns compared to traditional mortgage indices.
Understanding Mortgage Market Risks and Rewards
The discussion highlights the transient nature of risks involved in mortgage-backed securities, particularly emphasizing the impact of prepayment behaviors on yield. As interest rates fall, the likelihood of homeowners refinancing increases, thereby introducing additional uncertainty in cash flows. This aspect becomes critical when considering how new issue MBS behave compared to indexed products during declining rate environments. By carefully managing the duration and position in newer coupon bonds, one can potentially leverage those same risks into higher overall returns.
Navigating the Bond Market Amidst Macro Economic Factors
Market observations indicate a disconnect between short-term financial expectations and long-term economic realities, particularly in the context of rate cuts and their anticipated stimulative effects. The economic structure, with long-term fixed rates largely insulating borrowers from short-term fluctuations, fails to demonstrate the sensitivity that may have been expected. Discussions around corporate debt and consumer leverage further underline that recent rate hikes did not significantly stifle borrowing behaviors among corporate giants. The conclusion drawn is that further rate reductions may not yield the expected economic stimulation due to a fundamentally altered relationship between rates and economic responsiveness.
Harley Bassman, managing partner at Simplify Asset Management, outlines his favorite trades right now and explains why he thinks bonds are fully cooked without an imminent recession. He argues that selling interest rate vol is one of the best ways to play this fully cooked bond market and explains how new issue agency MBS and other callable bonds can be used to take advantage of the richness in bond volatility. Filmed on September 26, 2024.
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