Behavioural Consequences – The UK Bond Market Rigging Scandal

Health Warning: The UK Bond Market rigging issue is all behaviourally driven. We express a personal opinion in this post and do not endorse or condone breaking any jurisdiction’s sovereign laws.

We would like to contribute a very short thought piece on this issue. Our premise basically goes like this and is grounded in behavioural theory:

2012 Behaviour Matrix copy
2012 Behaviour Matrix copy (Photo credit: Robin Hutton)

Take away any sensible incentive (by over regulating the market participants) and you create the disincentive for cheating behaviour to manifest. Simple.

It is a natural competitive behaviour to ‘cheat’ or try to cheat a system that becomes ‘badly’ designed, as in the case of the highly over regulated bond market and an environment of very low yields.

We find is amazing that the popular press only tend to focus on one side of the equation and distort the real issue and underlying drivers that lead tot cheating behaviour.

Illustration for Cheating Français : Illustrat...
Illustration for Cheating Français : Illustration d’une antisèche Español: Ilustración de una chuleta Deutsch: Illustration zum Schummeln (Photo credit: Wikipedia)

The rule of law should be the overriding guiding principle and helping to design markets and market participant behaviours based on properly incentivised interactions is part of any regulatory system. In the recent past, we have forgotten to bear this in mind…

…and then we act surprised when market actors (participants) misbehave?

theMarketSoul ©2013

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US Treasury Yield Curves – Revisited mid July 2013

Seal of the United States Department of the Tr...
US Treasury Seal (Source: Wikipedia)

We resume our intermittent analysis of the US Treasury Yield Curves today with a comparison between the mid July 2013 versus mid July 2012 (in chart 1) and mid July 2013 versus mid July 2011 (chart 2).   US DoT Yield Curves Mid July 2013                       Chart 1 – Mid July 2013 versus mid July 2012 In the absence of any meaningful data on ‘proper’ yield curve rates, this analysis will have to do.   US DoT Yield Curves Mid July 2013vsJuly 2011 (1)                       Chart 2 – Mid July 2013 versus mid July 2011 Finally, we compare mid July 2013 versus mid July 2007 (chart 3), the last time we experienced an Inverted Yield Curve and had any meaningful Yield Curve data. Note that the short versus longer term yield rates had a much flatter yield rate curve than in the recent past.  This is partly a reflection on the risk profile of financial gilt debt instruments back in 2007 versus today.   US DoT Yield Curves Mid July 2013vsJuly 2007 Chart 3 – Mid July 2013 versus mid July 2007 theMarketSoul ©2013

Hidden ‘cost’ of Opportunity Cost

As economists (assuming that most of our readers have a vague interest in the subject matter we keep on harping on about most of the time) we should all be aware of, if not au fait with Opportunity Cost.

English: A production possibility frontier sho...
A production possibility frontier showing opportunity costs of moving between two of the points. (Photo: Wikipedia)

As a one line refresher: Opportunity Cost is the cost or value forgone by choice. Choosing one option or outcome over another, automatically leads to an alternative opportunity forgone, hence the cost element.

So the real challenge is to extract the ‘right’ amount of value or benefit from the chosen option versus the forgone option. This is the real difficulty when the counter-party does not share the same or a similar risk profile.

What is the answer then?

Well as vaguely competent economists our stock answer is: It depends!

Wieser coined the terms marginal utility and o...
Wieser coined the terms marginal utility and opportunity cost. (Photo: Wikipedia)

Lets peal this back one level and start with the this position: the very fact that you had a choice in the first place is a very good thing. A lot or market participants are never really afforded the luxury of this or any choice. They just have to lump it and get on with whatever activity keeps them sustained. Therefore, from this extreme position an answer might be that we should count our blessings and just accept the inevitable and get on with choosing and working through the consequences.

However, in a world driven by value maximisation, the fact that we have to make the optimum choice does become more significant and important. What tools can we employ in a world of Information overload, yet still Information Asymmetry to come up with the optimal solution?

Choices
Choices (Photo: Scarygami)

Answer on the back of a postcard please…

Do we value everything and understand nothing?

On reflection, the ‘mechanism’ established to rescue or save the Euro is indicative of the fact that we still understand very little and can control and short-circuit systems to some extent, yet we think we value everything.

Inflation, and dare we state it openly, serious inflation of double-digit proportions must now surely be back on the cards?

We realise that we are not the only and first publication to come up with this analysis.

Bloomberg reported on 30 September 2011 that European Inflation had unexpectedly jumped to 3%, up from 2.5% in August.  Yet, this is still a long way off a double digit scenario, however, the factors mentioned in the Bloomberg report included, the Greek Default (possibility) and the ECB actions still possible in terms of containing European wide inflation.

Although most economists predict that inflation will start to wane next year, we believe that actions like the Greek Debt haircut and the increase in the EFSF’s bailout fund to €1tr sends signals to the market that the value of money is now seriously ‘delinked’ from operational reality.

We will not comment here in depth on monetary policy, as it is currently applied, however, we are beginning to get the impression that inflation as ‘the silent and stealth’ taxation it really is, is now firmly (yet behind closed committee room doors) on the agenda to help “manage” the size of the European Debt mountain.

It is worth keeping an eye on the real drivers of inflation and then there is some value in keeping an open mind.

theMarketSoul ©2011

The Ice Age is Cometh

Originally published 4 October 2009:

Information Asymmetry is what drives the market. We alluded to this in an earlier blog posting (see Market Responsibility, Saturday, 18 October 2008). Yet we still hear the socialist agenda mention regularly that if it wasn’t for the recent government interventions to ‘save the market’, the market would have collapsed. We are sorry, but we just don’t buy this. Yes it is true that individual institutions in the market would have failed, but as a mechanism, the market would have wobbled and other participants would have picked up the distressed bits and pieces and carried on.

True, there was a crisis of liquidity in the system, with severe knock on effects, but as a mechanism for allocating resources, effort and reward, we still believe the market would have survived, with or without the ‘nuclear’ option intervention we saw. The moral of this tale is that unfortunately the socialist elite now believe and make the rest of the market believe that they hold the moral high ground and can dictate the agenda for the next several years. Oh well and so the pendulum swings…

Which was entirely a side track to the real intention behind this posting.

‘The Ice Age is Cometh’ was an article headline in the Radio Times edition of 16 – 22 November 1974. A friend of ours came out with the rank smelling edition of the Radio Times of late 1974, that he discovered stuffed in the chimney breast of his new home. Stuffed in that chimney-breast to obviously keep the cold draughts out, as according to the subtitle the next 1,000 years could be very, very cold, with an advance of the polar ice caps and glaciers. Did we blink or something? We will challenge the BBC to dig out the programme aired in the week of 16 – 22 November 1974 on BBC 2, so that we can be reminded how quickly the agenda and the focus can shift, if we take our eye off the ball and let information asymmetry spin the agenda out of our control.

And we suppose we cannot deny the evidence currently in front of our eyes. Polar ice caps are retreating, which is true if you focus purely on an evidence based approach to trying to understand the wider system. But do make your observations and emotive arguments from within the system, or do you need to step outside that system in order to be more objective. And what about intuition? On a purely intuitive level we believe the earth of GAIA is a self correcting system but we do not have enough evidence to conclusively prove this assertion.

So, in the meantime, we swing one generation to the next, waiting for the ‘Information Assymetrists’ (yes our new made up word de jour) to set the agenda and the morals of the market.

As a soul in this market arena we just keep on being amazed, day in and day out. Please just give us the ability to take the long view…

theMarketSoul ©2009

The US Treasury Yield Curves #2 – Do you factor inflation into the deal?

In the previous article we posted, mention was made of the (0.72)% [negative 0.72%] real return US Treasury investors can currently expect on 5 Year Treasury Bills.  The Nominal (quoted) Yield Curves and Real (Inflation adjusted) Yield Curves for two specific points in time, namely Friday 29 July 2011 and 30 July 2006 are listed below.

Yield Curve 1

What is interesting to note is the very flat nature of the Yield Curve for all T-Bills at the end of July 2006, at around a 5% Nominal Return for investors.  Yet the most significant fact is that the Real Yield was around 2.37% on 5 Year Treasuries, versus today’s (0.72)% on 5 Year or (0.18)% 7 Year T-Bill yields.  In order to generate a very small Real Return, you have to be looking at purchasing a 10 Year T-Bill to obtain a modest 0.38% Real Return in today’s market.

A cynic might make this remark:

“Not only do you pay your taxes, but with the negative Real Yields on both 5 & 7 Year T-Bills, you are paying the government to hold on to your cash too”

They win both ways!

theMarketSoul ©2011

Source Material:  US Treasury web site:

http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/Historic-Yield-Data-Visualization.aspx

The US Treasury Yield Curves – Are the markets really that bothered?


 

Department of Treasury Seal (2895964373)
Image via Wikipedia

As a general introduction today we will look at two US Treasury Yield curves.  The first Yield curve in the Curve graphic 1 below is the 3 Month bills compared to the 10 Year bills over the last 5 years.

Yield Curve 1

In this table it is clear that the current 10 Year rate of 2.82% as of 29 July 2011, is still well below the 5 year average rate.  The trend of the 3 Month bills, especially over the last few months has drifted aimlessly between 0.15% on 28 February 2011 and currently at 0.10% on 29 July 2011.  There is in fact no noticeable concern in the Bond / Capital market over the potential technical US Treasury default on 2 August 2011.

The second curve below in Curve graphic 2 illustrates this fact of the 3 Month bills trend since 28 February 2011 to 29 July 2011.  As can be observed, in the last few days a very slight spike has been observed, yet the rate at 0.10% is still below the 0.15% rate of 28 February 2011.

Yield Curve 2

In real monetary terms it is costing 5 Year Treasury bill holders (0.72%) (Yes a negative return of 0.72% currently to buy 5 Year Treasuries.  (See US Treasury web site)

It will be interesting to observe and track the trends over the coming days, especially as we kick off August and Debt Ceiling D-Day in the US congress and Senate.

theMarketSoul ©2011

Source Material:  US Treasury web site: http://www.treasury.gov/resource-center/Pages/default.aspx