MacroVoices #550 Harley Bassman: In FED We Trust

Macro Voices

In this episode, MacroVoices hosts Erik Townsend and Patrick Ceresna interview fixed income expert Harley Bassman to discuss the Federal Reserve's

Key takeaways

• Harley Bassman argues that the Federal Reserve's primary challenge is regaining market trust rather than just managing inflation rates.
• The U.S. fiscal deficit has reached approximately 6% of GDP, leading to concerns regarding the long-term stability of the U.S. dollar as a reserve currency.
• Mortgage-backed securities are experiencing increased negative convexity due to 'recouponing the stack' and a flattening yield curve.
• Hyperscalers such as Meta, Google, Amazon, Microsoft, and Oracle are projected to engage in massive borrowing to fund AI infrastructure competition.
• Patrick Ceresna proposes a long volatility trade using a January 2027 strangle on the iShares 20+ Year U.S. Treasury Bond ETF (TLT).

Main topics

• Federal Reserve Policy and Trust
• Fiscal Deficit and U.S. Debt
• Mortgage Convexity and Interest Rates

Notable quotes

What's really important here is the Fed needs to go and regain the trust of the market.

Conclusion

The episode provides a sophisticated look at how structural shifts in

Transcript preview

Speaker 1 (0:00) What's going on, in my view, is we have a lack of trust in the government, in a lot of our institutions, and maybe about the Fed. What's really important here is the Fed needs to go and regain the trust of the market. Speaker 3 (0:15) That was Harley Bassman, the fixed income guru who invented the Move Index and who's best known on the street as the convexity maven. I'm Eric Townsend, and this is Macro Voices, the free weekly podcast targeting professional finance and sophisticated private investors. Episode 550 was produced September 17th, 2026. Just hours before this week's feature interview was recorded, the Federal Reserve surprised hawkishly by not just hiking rates like everyone knew they were going to, but also signaling that another rate hike is likely to occur before Christmas. So Harley and I will start with the news and what it means, then move into a slide deck Harley prepared, giving us his take on markets and where they're headed. You'll find the slide deck linked in your Research Roundup email or at MacroVoices.com. And I'm Patrick Ceresna. Let's dive straight into this interview. Harley, I'm going to have to hit you up here. And sorry to do this to you, but you know, you sent us a slide deck a couple of days ago, and the title of it is In Fed We Trust. Now, we're recording this on Wednesday afternoon after the hawkish surprise. We had an expected rate hike, but then it went unexpectedly hawkish with a dot plot saying that's not the last hike in 2026. And that really shocked markets. Speaker 1 (1:35) Do you still trust the Fed this afternoon, Harley? Thank you for having me back on. I appreciate it. You have the best financial podcast on the planet, and it's an honor to be here. My last two commentaries have been advocating strongly for the Fed to hike 50. One and done, get it done. What's going on here? I think people are a little confused. Actually, they're not confused at all. We know that the economy or inflation... It's not going to matter if they go 25, 50, or even 100, for God's sakes. I mean, that really is not going to change a whole lot right now. What's going on, in my view, is we have a lack of trust in the government, in a lot of our institutions, and maybe about the Fed. And I think what's really important here is the Fed needs to go and regain the trust of the market. There's an adult in the room, this hand on the steering wheel. that's going to kind of guide, you know, the world's largest economy, or not economy, currency. And that's where it's at. And I think what he's trying to do is slowly get us off of forward guidance and, you know, other dot plots. He's trying to get off of that and get us back to the good old days where the market actually assessed risk and managed its risk accordingly, as opposed to being dependent upon the Fed and everything else. And I think what you've seen in the past. is that markets have gotten over their skis when the Fed gives too much guidance that changes their mind. I think what's happening right now is getting off forward guidance is like coming off smoking, or I'd say heroin, actually, but there's a family broadcast here. It's just hard to get off of it. And the market is becoming more volatile as we slowly back away. And I kind of think right now, cold turkey would have been the better idea. Up 50 would have been fine. The market was already priced for it. What are you waiting for? torturous for another 12 weeks because they're not going in October, clearly. It's before the election. So we're going to wait 12 weeks to go and do 25 more and then think about it. So that wasn't, this was not a good result today. It should have been zero or 50 in my view. Speaker 3 (3:40) Okay. Let's talk about what comes next now, because as you just said, you're describing a Federal Reserve that's kind of taking the steering wheel, wanting to show the market there's a... An adult at the wheel were your words. Okay. You know, something else we saw in very recent history was some people in the AI community spoke up and called for a slowdown in the progress of their own organization. That resulted in a pretty darn emotional reaction from some senior officials in the U.S. government, including the very top. And I'm not sure if we're necessarily feeling in that debate. like it's the adults that are feuding with one another. Is there a risk that the Fed is about to get into a fight with the Trump administration? And if so, how do you see that playing out? Speaker 1 (4:31) Jeez, you know, mom always said, don't discuss politics or religion in polite company. So I'm kind of like nervous about going where you're kind of taking me into because that is where the lack of trust. It's not good guy, bad guy. It's if you say something, do you follow through? That sort of trust. And we know that the Fed is a special entity. The Supreme Court a few weeks ago ruled that basically the executive branch, the president, can basically do what he wants to do. He can fire or hire anybody at will. They carved out the Fed. Now, the Fed really is an arm of the government. So logically, I guess if you can deal with the FCC or something else, why not be able to deal with the Fed? They said, no, the Fed is too special. It's too important. Basically, it's the governor on the world's reserve currency, and the president can't touch, the executive branch can't touch them. And I think that underlines the idea of the importance of gaining credibility and trust in the Fed, notwithstanding. a lack of trust in other parts of the government. Speaker 3 (5:39) Harley, we talked about the presidential administration overall, but let's narrow it a little bit more to specifically the Treasury Department. What do you think? If the Fed and Treasury get along, does that solve everything? Or do we need the Fed and the entire administration to agree on rates? Where does this go? And more importantly, do you see Secretary Besant and the Fed, FOMC, do you think they're going to get along? Speaker 1 (6:05) Look, Clearly, we have various activities going on between the executive branch, the congressional branch, and between various political parties, which are bothersome for everybody. I think that if the Fed, or and Treasury, if they can, I don't want to say hold hands, but if they can go and work in a symbiotic manner, not a 1951 Fed accord. you know, in public, but if they could work in a symbiotic manner, I think that's good enough. If the people think, if investors think, if foreign governments think that the financial policy of the United States... printer of the world's reserve currency is the adult in the room managing things with squabbles everywhere else, but the two, you know, dad and mom, or dad and dad in this case, I suppose, they're in a coordinated fashion where they got things under control and there's a path to a good result. That doesn't mean a good result today, a path to a good result. I think that's good enough. And I think that's happening right now. And Warsh is just having a, he's going slowly. And I think he, you know, to get his 12. zero vote today. He had to basically swallow hard and do 25. He probably wanted to do 50. I suppose he should have wanted to do 50 and get done with. But having unanimity was a good result. And so, yeah, it's going to hurt until December. But yeah, we're going there, I think. I think we're going there. Speaker 3 (7:29) Listeners, Harley prepared a slide deck to accompany this week's interview. You'll definitely want to down that. You can find it linked in your Research Roundup email. We've also tried to make this a little easier for you. It's no longer necessary to pass a registration wall. If you just want to download, click the button above. Harley's picture on our homepage, macrovoices.com, says looking for the downloads. That's been reprogrammed, hopefully it's working now, to take you to a page where you can download directly or you can subscribe to the Research Roundup email or both, whatever suits your fancy. Harley, let's dive into the slide deck. Which page number do you want to start on? Speaker 1 (8:05) Page four is fine. Let's dial back here. I'm really not going to talk about numbers. Do I think I can make an economic case for the Fed to hike rates? No, I don't. As a matter of fact, I can do a lot of cases that they could have held the rates flat, but that's not the deal here. It's a matter of building trust and trust has been damaged. And why has it been damaged? Slide four, corporate profits as a part of GDP basically doubled, gone from 6 % to 12%. We can, you know, wave our hands about why it's happened. Has it been because of the big tech firms? Is it because of government policy or who knows what? But clearly this feeling. is going through the economy and people are basically being unhappy about it. The next S &P versus Michigan sentiment, this is a really hard slide to read. I'll just sum it up that in general, what we had was these two things went in line. When people felt better, stocks went higher. When they felt worse, stocks went the other way. And what you've seen in the last X number of months is this alligator jaw opening of stocks going up and sentiment going down, which is basically just a measure of this. Next, housing affordability. It's terrible. It's as bad as it's been in 30 years. And affordability is simply, you know, median income versus median house price versus the interest rate. And basically, if house prices go up, incomes don't rise that much, and rates go up. And nobody is happy when they can't buy a house. It should be 61, 2, 3, 4 % of the population. And it's well known that the best family results occur in an intact family in a house. They all kind of all go together. And that's not happening right now. Where you really see the break apart is the next slide in the age of the first home being bought. It's basically gone from 32, 33 age to 38 in like five, six years. This is terrible. Is it a public policy result? Is it more random? Hard to say, but it's a reality that's happened, and no one can be happy with this kind of result. Speaker 3 (10:18) Harley, let's continue the slide deck on page eight, bank versus non-bank lending. So Speaker 1 (10:23) this is not news over here. We all know that the big non-bankers are coming in, private credit. Is that going to be a problem someday? Yeah, probably, but it doesn't matter. What's happening here is the non-bank entities. are disintermediating. the banking system. This is important because it just reduces the ability of the Fed to transmit their policy to the overall economy. Because banks basically work with the Fed, they borrow from the Fed, they price off the Fed. These non-bank entities, they're a little lower down in the capital structure and they lend as they want to. They're not as impacted by the Fed's rate. So once again, trust becomes more important than the policy rate itself. Slide nine. I think this is where the rubber meets the road about why rates are going up so much over here, aside from the lack of trust, is that there's just massive price incentive demand. The hyper scalers here on page nine, this is a projection. Is it going to happen? Who knows? But I mean, these numbers are out of control. You're talking about 750 million projected borrowing. The Treasury is issuing 2 billion. We're getting close to 30, 35 percent. competition for money. The Fed can't stop this. There's nothing they could do per se because these guys are going to borrow money at any rate, 6, 8, 10, 12. It doesn't matter. They're in an existential race to figure out what's going to happen. If you remember back to the original dot-com boom. All those companies there, you might have 10 companies all working in one small area. One of them won. Now, did you know which one was going to be? No. Did Pets.com win? No, they didn't. But some other pet company might have won. And so these people here are fighting it out. And I don't think there's a price where they will stop borrowing to go build out their systems. Speaker 3 (12:14) Harley, I'm going to ask you to take a tangent with me here because obviously everybody knows you are Mr. Fixed Income, inventor of the move index and so forth. I think this is so timely this week. You're a smart guy, so I just want to go in a totally different direction, a little bit outside your wheelhouse, which is, hey, this feud that started this week where Dario Amodi and other people said we have to slow down AI, at first everybody thought, oh my God, this is the catalyst that's going to crash the bubble in the AI and, you know, all the hyperscaler debt, it's all going to crash. It's, you know, this is the end. And then President Trump came out incredibly strongly, actually phoning into the All In podcast's live event, saying, full steam ahead, don't listen. I think he actually had some strong, personally critical language about some of the people that were raising other concerns. And it's very, very strong between President Trump and his economic advisor, David Sachs, that it's full steam ahead on AI. We're not going to regulate anything and we're not going to let these left-wing nutcase. pansies in San Francisco tell us what to do, is at least the way I interpreted it. Is this the beginning of something that could really unwind the AI trade, or is this just another political spectacle that's going to pass? Speaker 1 (13:30) I think the latter. Look, just because there's no specific law about something doesn't mean you can't do the right thing anyways. And I do think that the AI people have recognized there could be a problem here. I'm not a believer that we're going to have the end of civilization. in 10 years. I did see the movie in the 70s. It did not end well, but I don't think it's going to happen. But I do think it's possible that these are smart people who I assume some of them have an interest in the country overall, a little bit of patriotism, and a little bit of concern for the world overall. Yeah, there's a problem of what if China does it first or Russia or North Korea? I guess that exists, but I think it's possible to find a middle ground here where you don't have to go full steam ahead. And I suspect that there will be some internal controls, even despite various political Speaker 3 (14:22) wailings. And as a fixed income guy, how do you feel about this unprecedented? I think it might have, I don't remember if it was in your slide deck or somewhere else I saw this recently. I think the size of the AI and hyperscaler related debt is now bigger than the municipal bond market or something like that. I don't remember the statistic, but it was staggering. Is there something could go wrong here? Speaker 1 (14:44) I don't think so. I think, can we get higher rates because of their borrowing? Yes. But these guys have, most of them have underlying cash machines. They can certainly cover the cost of the debt. And I'm pretty sure unless there's a major standard oil kind of breakup of these companies, that they have the ability to go and pay off these debts eventually. Now, that doesn't mean the equity holders are going to do well. Profits might go down because of the spending. So the equity, I can't comment on, but I think the bonds are probably... money good. And if you tack on another 50, 100, 200 basis points, I think it's fine. I just don't see a bankruptcy with the hyperscalers. They all have underlying core businesses that are very profitable. Speaker 3 (15:25) Wait a minute. I don't think of the AI companies like Anthropic as being very profitable from the standpoint that really they're subsidizing a lot of their operations. Matt Berry told us last week that the risk in this whole AI market is... China giving it away for free, which was Google's tactic back in the 90s that really eliminated a lot of competition. And the way that plays out is Chinese AI models that are almost as good as Anthropic's best models get open sourced. And if you buy your own hardware, which also gives you the advantage of protecting the privacy of your data, you suddenly don't need Anthropic anymore because the free stuff from China is just as good. Now, that hasn't happened quite yet, but if it did, doesn't that put a lot of this industry at risk in terms of its ability to service that debt? Speaker 1 (16:14) Look, Anthropic