As a key measure of bond market volatility, the ICE BofA MOVE Index has been grabbing headlines as markets recalibrate their expectations for rate hikes. Today I'm pleased to welcome the creator of the MOVE, Harley Bassman. Harley, let's start with the big picture. We've seen a classic recession bellwether, the inverted U.S. Treasury Yield curve, persist for the longest duration on record, yet U.S. economic growth seems healthy even as we see market volatility. How do you interpret some of the key signals from the bond markets right now?

We have had inverted curve for a very long time. One could maybe say we had a recession in 2022. We did have two back-to-back quarters of negative GDP. So, one could say that was it, we already had it. I'm not sure I would go there, but what I really think is happening here is the Fed’s got behind the curve on inflation for a lot of reasons. I would say primarily because of politics, that Biden dragged his feet on renominating Powell. I think Powell was ... he did not want to hike rates when we first saw inflation coming because he wanted to get renominated and there was talk of Lael Brainard coming on or some other more dovish person. Then he tried to catch up and he's gone more then he should have perhaps, but that's kind of his view of things.

I think the other side of the coin though, is to get an inverted curve, you need two things to happen. One, you need a high front end, but two, you need a low back end. I think pushing rates up to this level we haven't seen in really 15 years, is a lot of the asset liability managers who really drive real money, not the hedge funds or mom-and-pop, the really big guys, especially the defined benefit managers. So it's mostly gone now, but it still exists where you retire from your job and they say, we're going to give you X dollars per month, as opposed to the newer ones where we'll give you X money in your 401(K) and you invest it yourself. And insurance companies also mixing when you're going to die in 30 or 40 years versus what they can make now, we get rates up to 4 or 5% on govvies and five, six on IG corporates.

These guys are finally back in balance for the first time in 20 years. They've been running big deficits. They can sell stocks, buy bonds and lock this thing and put it away, keep their jobs. I think what's happening here is we're just running into this massive demand for long-liability assets to go into fees and risk. So that’s what’s driving the curve right now more than anything else.

Will we get a recession? Of course, we will. We’ll always get a recession. Is it going to happen tomorrow? I think not. I also think that this notion that 4, 5% is a brake on the economy is only a concept that exists because we lived in a 0% world for 10 years. If you go back in history, I mean, we spent most of our lifetimes in this 4, 5% area in the economy and did just fine. So I think we have a little brain freeze from, call it a post-GFC hangover of zero rates.

You started off your answer to that question regarding the why, and the one thing I've always wanted to know is did we conveniently, for whatever the reason, political policy or otherwise, did we conveniently change the definition of a recession, the classical definition of a recession based on the way you answered the first question?

Recessions usually are not announced until X months after we've had the various events. Did we want to define a recession in 2022? I don't think so. I really think this is more about (the fact) we had massive government intervention, both monetary and fiscal for a decade, and that put a thumb on the scale for a lot of stuff. For a while there, the Fed was buying more TIPS than were being created. So when we had negative real rates and TIPS, I mean was that a signal of bad tidings ahead? I guess it might've been. I would say it's the Fed just jamming the market.

You're asking about, we have this information from the yield curve. And the reason why you want to have a free market in financial assets, especially interest rates, is that is a feedback loop to give us and the Fed and the government and businesses feedback information about where the economy is, where supply/demand is for money. The government, the Fed and fiscal, kind of put their thumb on the scale and made it so we didn't quite really have a clear view. We're getting a clearer view now of things. So I think to some degree, it's just the pendulum swinging back from the Fed's thumb on the scale for a decade.

The era of low rates is over and the Fed appears to have become more interventionist post the global financial crisis, for example, stepping in with massive QE during the initial COVID panic. What might this backdrop mean for interest rate volatility, and how do we interpret the MOVE index in light of those macro events?

The MOVE Index is a real number. It's not an index per se, it's a real number. If the MOVE's at 100, if you divide that by 16, you get roughly six. That is the theoretically the option market priced-in volatility for the next 30 days or actually 21 trading days for the bond market. The market expects six basis points a day close to close every day for 21 days. Same thing with the VIX. Take the VIX and divide that by 16 and you get a number. So a VIX of 15 is like 0.9% every day on the S&P.

We have seen, realized volatility on the MOVE in the low 100s and thus a MOVE at 110 is not a shock at all. I mean usually, you see implied vol eight to 12% over realized vol for most liquid assets. Why did this happen? So the question is, why did we have this massive doubling? Why did the MOVE double and the VIX hasn't? Well, number one is because rates are moving a lot and the S&P is not moving that much. So why are rates moving so much and the stock market isn’t?

If you go back through the Fed commentaries two, three years ago, they were telling you as recently as late '21 that with the dots, they expected no change in rates to early 2024. And the market kind of priced that in and all of a sudden, they changed their minds by 500 basis points. Everyone was totally off sides. And then it’s a matter of, okay, we've got rid of that, where are we going to go? And what we didn't know was where was the top? Was it three? Was it four? Was it five? We had a 9% inflation number for a while. That's why the market was moving so much is we just didn't know where rates were going to be.

We kind of know now where they're going to be, and I think the MOVE is going south from here. But the answer is, we've had uncertainty in interest rates and Fed policy. We have not had uncertainty in corporate earnings. They've been kind of chugging along nicely and that's why the stock market has been slowly grinding higher in a very orderly fashion.

Certainly, there's a change of market segment as you've seen to the point of grinding higher, you see the impact on the financial markets ... finding market participants and where that's going. If you look at some of the macro tech names that are going there because people are trying to guess and when that right time is, but between the two, but you wouldn't call the MOVE, I think you've said in the past that MOVE is not a leading indicator of the direction. Do you agree with that?

Yes. I'll say in general that is true. The MOVE is only one month, man. I mean it's hard to go and get, and also the MOVE does not give you skew like where the at-the-money options are pricing in. So the MOVE by itself, it's a window between now and the next payroll number is kind of what it is, but I mean, that's informative. I do think that you will see the MOVE and the VIX also go up or down depending upon where it is within the range.

So when we get tens back to 5%, you're going to go and see the MOVE go up because now it's like, oh my God, are we going to go back into the range or are we going to break out to do territory? Whereas if you're in the middle of the range, the MOVE will be lower. Now this is really almost a micro-technical thing that I would never advise them to trade upon, but I'm trying to answer your question that is there information, it's information not about direction, but about the level of uncertainty around where we are right now.

I think how you capture between now and the next payroll number is great. I mean, as I see the markets react during each session at the end of the day, everyone's trying to pick up that point on the curve where they're going to make and express their opinion around those macroeconomic data releases. For us at ICE, we’re trying to play a larger role in the mortgage markets and ultimately improve pricing accuracy and prepayment modeling for mortgage-backed securities or MBS. MBS is an area where you also have a lot of experience. Could you talk us through a little bit of what you're seeing in terms of market dynamics within the MBS segment? That's certainly near and dear, not only to the investments we've made, but also to a large part of the community that we service today.

I mean, MBS, that's my wheelhouse, man. That's where I spent most of my career. And I'll say to you right now, I think newly issued mortgage bonds are the cheapest bond, fixed income asset available. Period. Not the mortgage index securities like MBB. MBB because it's a fine investment per se, but that's mostly Fannie 3's and mortgage bonds issued three, four years ago.

So, 72% of the mortgage index is 2% to 3.5% coupons. Now those aren't really mortgages, they're just kind of bonds. New mortgages issued in the last year and a half, so 5.5, 6% bonds and those are very interesting and they are trading maybe 150 basis points over the 10 Year, that is double the historical average, which is 75. It's also about 85 basis points higher than corporate bonds with credit risk, whereas mortgage bonds have no credit risk. They have prepayment risk, they have convexity risk, but they're not going to default. And if Fannie and Freddie default, my advice to you is to buy cans of tuna, guns and small domination gold coins because it'll be the end of civilization if Fannie goes bankrupt.

I've heard you say in previous interviews that there are three main risks in the financial markets: duration, credit and convexity. Broadly speaking, how do you view those risks at this moment? Is there one leading the other? Are they moving in unison? Help us understand how you view that world at the macro level.

If you dial back to call it 50,000 feet. So, an observation that exists, but I would not trade on in short term. Duration, credit, convexity all travel together. Duration is when you get your money back and we'll measure that by maturity. Do you want to buy a three-month bond, a two-year bond, a thirty-year bond? Thirty-year bond clearly has more risk, both up and down. It's not necessarily bad, it's just more movement per basis point. Credit, if you get your money back as you take on more credit risk, the odds of it defaulting, increasing, you should get paid more money. And convexity is how you get it back. In simple terms, convexity is this: if I have an investment where I could make a dollar or lose a dollar for even coin flips, zero convexity. So a Treasury is more or less zero convexity, it does have convexity, but we'll ignore that.

If you could make two lose one, positive convexity. If you could lose three, make two, negative convexity, that's all you got to know about convexity. Now the harder question is what's it worth? If I have a zero convexity bond that yields 5%, a bond, similar bond that makes two, loses one, what should that yield? Well, all I know for sure is it should yield less because it's a better bond. How much less? So if I have a 5% zero-convexity bond could yield four three quarters, four and a half, four, three, I don't know. I mean, but that's where the geeks come in. Similarly, if you have a lose three, make two bond, it better yield more. Otherwise, you're making a bad trade. How much more should it yield? What I'm saying to you is a mortgage bond is a negatively convex bond. It's a lose three, make two kind of bond.

It has an extra yield of one and a half percentage points, which is double what it usually offers. I think taking convexity risk right now is a better risk-return investment than taking duration or credit. Credit, you have IG credit at like 55 over that's well below its average. You have junk bonds at like 350-60 that's below its long-term average. For duration, you have an inward yield curve. You get paid less to take more risk. So I'm looking at both of those and I can go to the convexity one. So you shouldn't put all your eggs in one basket, but if you're bucketing all three, you should migrate some money from credit into convexity and for the convexity bet, what you want to do is buy newly issued mortgage bonds, which is what we offer in our MTBA product.

Harley, it's been great spending a few minutes with you. I appreciate all the advice and counsel. I know all of our listeners will do the same. Thank you so much not only for what you helped invent and help us as an industry understand the pieces of the puzzle, but also what you continue to do to explain it to us each and every day. We appreciate the time very much today.

Thank you so much. Remember, it's sizing is more important than entry level.

Got it. Thank you, sir.