MacroVoices #550 Harley Bassman: In FED We Trust

Key Points

• The Federal Reserve delivered a hawkish surprise by hiking rates and signaling another hike before Christmas, shaking market confidence.
• Harley Bassman argues the core issue is not inflation or economic data but a lack of trust in government institutions, especially the Fed.
• The Fed must regain market trust and credibility by acting as "the adult in the room" and gradually stepping away from forward guidance and dot plots.
• Bassman preferred a single 50 basis point hike ("one and done") rather than a prolonged, drawn-out tightening cycle.
• Corporate profits as a share of GDP have doubled (6% to 12%), contributing to public dissatisfaction and distrust.
• A growing disconnect exists between rising stock prices and falling consumer sentiment (Michigan sentiment), signaling eroding trust.
• Housing affordability is at a 30-year low, with the average age of first-time homebuyers rising from 32 to 38 in just five to six years.
• Non-bank lenders and private credit are disintermediating banks, weakening the Fed's ability to transmit monetary policy.
• Hyperscaler AI borrowing creates massive price-insensitive demand for capital, pushing rates higher regardless of Fed policy.
• Bassman views the AI debt as manageable for bondholders because hyperscalers have strong underlying cash flows, though equity risk remains.
• The debate over slowing AI development is likely a political spectacle rather than a genuine threat to the AI trade.
• US debt-to-GDP and fiscal deficits are worsening, with a 6% deficit during peacetime and low unemployment described as gross irresponsibility.
• The TIPS break-even inflation spread (234 bps) suggests markets are not primarily worried about inflation, reinforcing the trust narrative.
• Rising rates reflect concerns about the US as a going concern and the cost of holding dollars as a core asset.
• The Fed and Treasury must work symbiotically to restore confidence, even if full coordination isn't publicly formalized.

Summary

In this Macrovoices episode, host Eric Townsend and co-host Patrick Ceresna interview Harley Bassman, the fixed income expert known as the "Convexity Maven" and inventor of the Move Index. The discussion centers on the Federal Reserve's hawkish surprise rate hike and its implications for markets, trust, and the broader economy.

Bassman opens by arguing that the Fed's decision to hike rates and signal further tightening before Christmas was a mistake. He had advocated for a single 50 basis point hike—"one and done"—to resolve uncertainty quickly. Instead, the Fed opted for a gradual approach, prolonging market anxiety for another 12 weeks. Bassman emphasizes that the real issue isn't inflation or economic fundamentals but a deep lack of trust in government institutions, including the Fed. Restoring that trust is critical, and the Fed must demonstrate it is "the adult in the room" steering the world's largest economy and reserve currency.

The conversation then turns to Bassman's slide deck, titled "In Fed We Trust." He highlights several troubling trends: corporate profits as a share of GDP have doubled from 6% to 12%, fueling public discontent; stock prices and consumer sentiment have diverged sharply, reflecting eroding trust; and housing affordability is at a 30-year low, with the average age of first-time homebuyers jumping from 32 to 38 in just five to six years. Additionally, non-bank lenders and private credit are disintermediating traditional banks, weakening the Fed's ability to transmit monetary policy.

A significant portion of the discussion focuses on hyperscaler AI borrowing, which Bassman describes as massive price-insensitive demand. These companies will borrow at any rate to build out their systems, creating upward pressure on rates that the Fed cannot control. While Bassman acknowledges the equity risk in AI, he believes the bonds are "money good" because hyperscalers have strong underlying cash flows. He compares the current AI race to the dot-com boom, predicting only a few winners will emerge.

The interview also touches on the political feud over AI development, with Bassman dismissing it as a passing spectacle. He notes that despite political rhetoric, internal controls and a middle ground are likely. On fiscal policy, Bassman warns that a 6% deficit during peacetime and low unemployment is grossly irresponsible, contributing to rising rates as investors question the US as a going concern.

Finally, Bassman points to the TIPS break-even inflation spread of 234 basis points, arguing that markets are not primarily concerned about inflation. Instead, the focus should be on rebuilding trust in the Fed and Treasury. He concludes that if the two institutions can work symbiotically, even without formal coordination, it may be sufficient to restore confidence and guide the economy toward a positive outcome.