MOVE Creator Says Yield Curve Inversion Will End `in Tears'

(Bloomberg) -- The inventor of one of the most widely followed indicators of the U.S. Treasury market says the inversion of a little-watched interest rate curve signals a disturbance in the markets ahead.

A move by the five-year, five-year swap rate below the Fed funds rate is a signal to shift into long convexity trades, which would pay off in the event of a large fluctuation in interest rates, according to Harley Bassman, who invented the Merrill Option Volatility Estimate Index while working at Merrill Lynch & Co. in the early 1990s.

“It's never different this time,” he wrote in a blog postdated May 30. “I don't know how or when it will resolve, but the yield curve has inverted in a half-dozen places, and eventually this ends in tears.”

Different flavors of the U.S. yield curve have inverted this year, a phenomenon often viewed by markets as a recession indicator because inversions have proven to be relatively reliable predictors of downturns in the past. Which yield curve to follow is a matter of some debate on Wall Street.

Read more: The Yield Curve Is Inverted! Remind Me Why I Care: QuickTake

“Let's keep our heads clear, it is not time to panic,” Bassman said in his note.

Bassman said he is covering short positions in out-of-the-money options and buying calls on the S&P 500 that would pay off if the trade war is resolved. He said he is also making leveraged bets on mid-grade credit, mortgage-backed securities, closed-end municipal bond funds and mortgage REITs on conviction the Federal Reserve will cut borrowing costs.

To contact the reporter on this story: Gregor Stuart Hunter in Hong Kong at ghunter21@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Joanna Ossinger, Ven Ram

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