MacroVoices #550 Harley Bassman: In FED We Trust

In this episode of MacroVoices, fixed income expert Harley Bassman discusses the Federal Reserve's hawkish September 2026 rate hike decision and its broader implications for markets and trust in institutions. Bassman argues that the real problem isn't inflation but a fundamental lack of trust in government institutions, particularly regarding fiscal responsibility. He contends that the 6% fiscal deficit during non-recessionary times represents gross irresponsibility and is the primary driver of rising rates, not inflation concerns. The TIPS-Treasury spread at 2.35% indicates the market isn't genuinely worried about inflation, suggesting investors are instead concerned about the U.S. dollar's value and America's status as a reserve currency. Bassman advocates for the Fed to regain credibility through coordinated action with Treasury, comparing the relationship to "dad and mom" working together to manage financial policy, though he would have preferred a 50 basis point rate hike to end forward guidance more decisively rather than the 25 basis point hike followed by signaling another hike before Christmas.

On mortgage-backed securities, Bassman explains the "convexity beast" problem: recent recouponing of the mortgage market stack has shifted the composition from 71% low-coupon mortgages to 51%, creating a portfolio heavily weighted toward 5.5% coupons that are deeply negatively convex. As the yield curve flattens, mortgage spreads widen from 95 to 110 basis points, increasing negative convexity and creating potential market stress. He details how mortgage bonds function as covered call positions with capped upside at strike prices, making them increasingly risky as rates rise.

Regarding AI and the hyperscaler debt phenomenon, Bassman acknowledges the $750 million in projected AI infrastructure borrowing creates legitimate demand pressure competing with Treasury issuance, but he doesn't foresee default risk because hyperscalers maintain underlying profitable businesses. He disputes concerns that AI will eliminate human alpha generation, arguing that current AI systems react to news rather than predict the future, and that human creativity and character remain valuable. He draws parallels to the dot-com era where multiple competitors existed but only a few winners emerged.

On fiscal solutions, Bassman proposes Simpson-Bowles style reforms including uncapping Social Security (currently at $184,000), raising retirement age gradually to reflect increased lifespans, means-testing Social Security and Medicare, eliminating step-up basis in estates, and solving "70-30 issues" where 70% of the public agrees on policy. He emphasizes that restoring trust requires demonstrating a credible path to fixing fiscal problems, not solving them overnight.

Bassman also discusses ETF risks, highlighting leverage considerations (linear leverage acceptable, daily percentage leverage problematic), return of capital issues where distributions exceed underlying income (indicating self-liquidating funds), and liquidity risks for ETFs holding illiquid derivatives or total return swaps. He addresses stablecoin statecraft positively, arguing USD-backed stablecoins create demand for Treasuries without creating meaningful competition from other currencies due to insufficient underlying asset liquidity.

The Market Desk segment, hosted by Patrick Ceresna and Noah Masil, provides technical analysis: Patrick recommends a long strangle on TLT (20+ year Treasury ETF) betting on volatility expansion, while the market discussion covers Fed credibility issues, Treasury yields at 5%, CTA triggers threatening equity markets, oil above $100 supported by geopolitical risk and constrained supply, dollar strength following the Fed's hawkish signal, gold consolidation around $4,400, copper's crowded bullish positioning at 5-year extremes, and natural gas at extreme net short positioning vulnerable to a squeeze.