I’ve been thinking and I want to update my stance. It is just a subtle distinction, but when the govt. buys up bonds in order to push rates down they are manipulating the fundamentals, not the market. There is physically less supply of bonds, so then price reflects that fact. If the govt. wanted to manipulate the market they would have to somehow drive the price up and have that price not reflect the reality of the status of bonds. I don’t think it is even possible to manipulate a healthy futures market in the long run… which is a really cool thing. I will nerd out about it all day long.
…I guess OPEC could be said to effectively manipulate the oil market. In theory it is not manipulation in my book since, again, they are supposed to making statements about manipulating fundamentals which in turn drive price. However, lets be realistic. How often do they follow through completely.
All markets are vulnerable to this sort of thing though. That’s the job of price discovery.
My main point is that is is mechanically very difficult to force a futures market to discover the wrong price in the long run and that is purely a function of its size and liquidity. Whereas a small market with limited units and participants is easily manipulated.
I am not sure that I find this statement relevant.
Western central banks don’t purchase stocks on the open market (although I seem to remember reading once that Israel was doing in) and so the supply and demand of shares is not directly affected by monetary policy (I bolded “directly” because obviously stocks are much affected by monetary policy but indirectly).
On the other hand, western central banks have always resorted to open market operations to manage interest rates by buying government securities. The OPEC has always intervened to reduce / augment oil production.
So these latter 2 markets (government securities and oil) are structurally very different from the stock market. Apples and oranges IMO.
What I meant by all markets being vulnerable to “this sort of thing” was that all markets get tossed around by rumors/ information that may or may NOT come to pass as material fundamentals. Is the rumor that a company is going to get bought out “manipulation” of the market? Who know, the market does not care. It’s job is just to price in as efficiently as possible the best version of reality.
I wanted to make the distinction between a market being swayed by a rumor (or announcement that something is about to change in the fundamentals such as a bond buy up or an oil production cut)…and a market that is possibly open to miss pricing due to failure of the market to operate efficiently.
Back to my original discussion about ZN vs the Govt. bond auction for 10year treasuries. Seem like the later market is too small to efficiently “discover” price. The futures market is better equipped. For example, if demand for 10years was all the sudden very high due to a drastically changing fundamental environment, seems like a market as small as the govt. auction could easily overprice the bonds. Whereas in the futures market, no matter how overbought or oversold the market is there is ALWAYS some day trader waiting to take the unsavory sides of trades like buying in an overbought market or selling in an over sold market. My point is that liquidity is always there to nail the price back to the fundamentals. It is relentless until balance is found.
I guess the question I have after all of this… would the govt, bond market be weaker without the futures market to nail price down?
I think it’s correct and obvious to say the higher volume/liquid product will dictate price more often than not. To your point, it’s also fair to say more developed and complete markets (those with liquid derivatives) do provide more pricing information.
Perhaps what is interesting is when the illiquid market drives price in the larger market.
An example is during the election runup. The SP moved in response to changes in polls. In that scenario, it was cheaper to spend money shifting polls than moving the SP.
