About Harley: There is but one “Convexity Maven” in the world, a moniker that belongs uniquely to Harley Bassman. A 35-year career in financial markets has left Harley steeped in all things relating to the price of and characteristics of optionality.
Dean Curnutt of Macro Risk Advisors interviews “Convexity Maven” Harley Bassman
- Is there too much short convexity out there?
- Not in listed option markets where there’s a clearinghouse and vol is explicit traded and monitored
- Risk is in the implicit convexity similar to portfolio insurance
- Bassman on volatility surfaces
- Term structure reflect flows; SPX has option sellers near term and insurance company buying in the longer term
- Skew in bond markets has flipped since GFC. Pre-GFC puts were richer than calls as large asset managers hedged their bond exposures buying puts. Since GFC, the market recognizes that low interest rates are more coincident with financial stress which has re-priced the upside higher.
- Forwards will typically price in line with long term options
- Structured note issuance has vol-suppressing influence on surfaces
- Europe has more structured note issuance b/c older more income-demanding demographic (looks more like covered calls)
- Auto-callables in Asia suppresses downside vol (until roughly 10-15% knockout levels)
- Bassman on a low interest rate worldWith central banks setting policy rates negative, the market is setting pricing across the curve very low.
- Germany is -.20% out to 10 years yet have nominal positive growth and breakeven inflation is priced at 90 bps, so an extremely negative real interest rate out 10 years.
Demographic motivated argument for secular stagnation
- Negative short term rates are not unprecedented and typically accompany short-term market stress. Insurance premium to secure assets
- Longer term negative rates are a symptom of market expectations for slower growth due to demographic headwinds.
- In US boomers are getting older. Japan is further ahead and Europe behind Japan.
- Declining labor force participation is biggest concern since growth = total hours worked x productivity
- Labor force participation and yields are correlated over long periods
- The trend of each decade is bluntly explained by demographics but it’s slow moving and difficult to trade
- Immigration necessary to balance the ratio of workers to retirees. Immigration very important.
- Trump is a symptom of low wage growth
- Bassman believes QE1 was necessary to save economic system but later rounds of stimulus should have been fiscal not monetary. Monetary has caused asset inflation without wage growth. Inflation therefore was uneven and regressive leading to Trump and dissatisfied public
- It’s coming. 2029 boomers will be fully retired and Republicans will not want to cut spending so there will be no check on Democrats
- Japan a good example that MMT can work in the short term if you borrow in your own currency. The issue is that MMT will not be restrained even if inflation starts to emerge so is likely bad idea in grand scheme
- The fallout can take decades but it’s not sustainable to print money at a faster rate than the economy grows
- Since bond vol term structure is flat, buy long dated (10 year) vol to hedge against longer term seismic shift while levering coupons on CEFs, MLPs, REITs and/or sell puts in 1 to 3 years bond options since demographics will limit rate upside to 3-4%. Can lever the near dated trades while owning the vol protection. This is a version of long time spread since near-dated levering or outright option selling is all short vol.
- Outright tail protection too expensive and path dependent to be relied upon