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This is notable because the change in perceived risk (as measured by the yield) of default appears greater in the shorter term government debt (1mo) as compared

by zcarter 13y ago

This is notable because the change in perceived risk (as measured by the yield) of default appears greater in the shorter term government debt (1mo) as compared to the debt maturing later (3mo). It would indicate that "the market" believes there may be some technical non payment scenario over the short term (so, government shutdown related), but there appears to be no fear-mongery shaking of the faith in the nation. As you can see in the link the 30yr bond's yield has in fact fallen over the same period. As this is a technical crowd, and there are requests for layman explanations, I'll elaborate some: Yield = Interest rate. This is inverse to the price of the bond. If you hold a bond and the yield rises (say, from 10bps to 27bps), you have lost money on your holding since the market price fell. The unexpected yield increase (price fall) on short term treasuries is notable because short term government bonds are held in large quantity by very risk averse investors (e.g. money market accounts) that not expecting to take losses. The unlikely downside scenario of a one off non-payment or deferred payment may cause settlement problems in short-term bond markets, or even a "freeze" as happened after Lehman collapsed. Typically the yield of a bond increases over longer maturities because there is more time for something to potentially go wrong leading to an inability to pay. Thankfully, the United States is a sovereign nation that prints its money on keyboards, so that is only possible if a decision not to pay is made.

hacknat 13y ago
>> It would indicate that "the market" believes there may be some technical non payment scenario over the short term It may seem ludicrous to an outsider, but it makes sense that if the market believes that the odds of the 1 month being delayed are significant, but the odds of the 3 month being delayed are insignificant, the 1 month would see a yield increase. If anybody has 10 billion dollars lying around this is an excellent arbitrage opportunity ;)
- zcarter 13y ago
  If only LTCM were still around :(
  - JumpCrisscross 13y ago
    Not sure if it was intentional, but this is precisely the trade that blew up LTCM. They bet on "convergence" in Russia's short-term debt. Russia repaid the favour by defaulting.
30thElement 13y ago
There's also what's called prepayment risk (or in this scenario I guess late-payment risk, but they're 2 sides of the same coin). For prepayment risk, essentially an investor thinks "OK, I put a lot of effort into this investment, but I don't have to worry about it for another x years". But the next month the investment returns at say a 15% yield, which would normally be great, but now you suddenly have to figure out what to do with that money and there may not be a similar quality investment around, at least one that's easy to find. In this case, the bonds are such short term that the banks are probably using them basically as cash on hand to pay bills that are due at the end of the month or something while getting some return along the way. If the payment is delayed (or god forbid defaulted on entirely) suddenly they can't pay their bills. Then they have to either pull out of their other investments early (which will drop the prices of those investments), or turn to their own bond holders/power companies and say "it's not our fault we can't pay, it's the governments" which leads to a not-so-nice cascading effect. That's why Wall Street is so unsure what will happen, they aren't sure what they can do in the situation and how far their actions will cascade out.
javert 13y ago
> Yield = Interest rate. This is inverse to the price of the bond. Why is that? Isn't the interest rate of a bond a constant that is set by the seller of the bond? So if the bond becomes more risky, the interest rate doesn't change, but the market value of the bond goes down. Put differently, the Treasury could offer a bond with a higher interest rate, but for the same "amount," in order to raise more money. I don't know anything about bonds or the Treasury, and I am just trying to reason it out, so please let me know if I have a mistaken premise.
- grinnbearit 13y ago
  Bonds are a contract saying, "I'll pay you a fixed amount of money after a fixed amount of time". They then try to sell that contract on the open market. Depending on how risky the market perceives the contract to be, the price could be a lot lower (increasing the effective interest rate)
- dllthomas 13y ago
  It's just how things are defined. Bonds have a value. Bonds have a term. Bonds have a price. The first two are fixed; the third changes with supply and demand. The yield is defined implicitly by these.
- Nick_C 13y ago
  > interest rate doesn't change You're probably thinking of the coupon rate. The yield is a different thing.

by zcarter 13y ago

hacknat 13y ago

>> It would indicate that "the market" believes there may be some technical non payment scenario over the short term It may seem ludicrous to an outsider, but it makes sense that if the market believes that the odds of the 1 month being delayed are significant, but the odds of the 3 month being delayed are insignificant, the 1 month would see a yield increase. If anybody has 10 billion dollars lying around this is an excellent arbitrage opportunity ;)

zcarter 13y ago
If only LTCM were still around :(
- JumpCrisscross 13y ago
  Not sure if it was intentional, but this is precisely the trade that blew up LTCM. They bet on "convergence" in Russia's short-term debt. Russia repaid the favour by defaulting.

30thElement 13y ago

There's also what's called prepayment risk (or in this scenario I guess late-payment risk, but they're 2 sides of the same coin). For prepayment risk, essentially an investor thinks "OK, I put a lot of effort into this investment, but I don't have to worry about it for another x years". But the next month the investment returns at say a 15% yield, which would normally be great, but now you suddenly have to figure out what to do with that money and there may not be a similar quality investment around, at least one that's easy to find. In this case, the bonds are such short term that the banks are probably using them basically as cash on hand to pay bills that are due at the end of the month or something while getting some return along the way. If the payment is delayed (or god forbid defaulted on entirely) suddenly they can't pay their bills. Then they have to either pull out of their other investments early (which will drop the prices of those investments), or turn to their own bond holders/power companies and say "it's not our fault we can't pay, it's the governments" which leads to a not-so-nice cascading effect. That's why Wall Street is so unsure what will happen, they aren't sure what they can do in the situation and how far their actions will cascade out.

javert 13y ago

> Yield = Interest rate. This is inverse to the price of the bond. Why is that? Isn't the interest rate of a bond a constant that is set by the seller of the bond? So if the bond becomes more risky, the interest rate doesn't change, but the market value of the bond goes down. Put differently, the Treasury could offer a bond with a higher interest rate, but for the same "amount," in order to raise more money. I don't know anything about bonds or the Treasury, and I am just trying to reason it out, so please let me know if I have a mistaken premise.

grinnbearit 13y ago
Bonds are a contract saying, "I'll pay you a fixed amount of money after a fixed amount of time". They then try to sell that contract on the open market. Depending on how risky the market perceives the contract to be, the price could be a lot lower (increasing the effective interest rate)
dllthomas 13y ago
It's just how things are defined. Bonds have a value. Bonds have a term. Bonds have a price. The first two are fixed; the third changes with supply and demand. The yield is defined implicitly by these.
Nick_C 13y ago
> interest rate doesn't change You're probably thinking of the coupon rate. The yield is a different thing.