Britain finally got its long-awaited exceptionalism in recent weeks, experiencing a yadda yadda yadda (you know the story).

Little value emerged from last month’s messes, but a valuable development is the creation of the ‘dumb risk premium’ – in short, the extra money the UK is paying to borrow because its leaders are a few sandwiches away of a snack.

TS Lombard’s inimitable Dario Perkins seems to have coined the term…

… which is now quite widespread.

Section I: Signs you may have MRP

If you’re just getting started with MRP, here’s what we’re talking about. The yield on 30-year gilts has risen much faster than equivalent bonds in other countries since Liz Truss and the wild gang took power in early September:

In case you’re worried, this unfairly focuses on the time elapsed since the author joined Alphaville Truss entered at number 10 (September 5), here’s a view from the start of the year:

The line chart of the bounty has started steadily since Truss became heir apparent to the Tory leadership, but has exploded since last month, showing Truss' problems

As this chart shows more clearly, the UK has a potential partner in Italy, whose own MRP peaked in mid-June when former Prime Minister Mario Draghi’s leadership fell into crisis.

Of course, 30-year gilts are arguably special because that’s where the Bank of England has chosen to step in, in part because of their role in liability-driven investment structures. The picture is a bit better over 10 years, but still ugly – here’s the spread against bunds year-to-date:

The line graph of MRP is not only visible in the long-term view showing Near, Far, Wherever You Are

Italy has moved closer to the pack in recent weeks despite replacing the technocratic, market-friendly former European Central Bank president with a party that, in the words of the FT, has “few candidates evident in the post of Minister of Finance”.

The parallels between Italy and the UK seem increasingly relevant given the ongoing political crisis in Westminster. Interestingly, the “fiscal event” marked one of the few times, going back to the turn of the century, when the spread between the 30-year gilts and the equivalent bunds was greater than the Italy/ Germany :

UK's MRP line chart (versus Germany) is now worse than Italy's showing Roman candles

The other side of the event was its effect on interest rate probabilities. Here’s how the overnight index swap’s implied expectation of rate change by next summer has changed for the BOE/ECB/Fed in the era of the Truss:

The MRP line chart was also visible in interest rate expectations showing unwanted interest

Even more so than with sovereign bonds, getting a clear reading here is… a struggle. There are many reasons why rate expectations change, especially so far. So we’re going to focus on gilts — but given that interest rate hikes have a quick and painful impact on the about 30% of people who live in variable rate mortgaged propertyit’s worth considering the silly impact here too.

Part Two: MRP Pricing

Scrolling further, you agree to understand the following statement: financial markets are complicated and the movements of something as integral as gilts will inevitably be the product of a combination of factors, yadda yadda yadda yadda…


Getting a clean reading on MRP is difficult. To start, we have to choose what is not stupid. Inevitably, some readers are going to go pretty crazy if we choose Germany and the European Central Bank. Sorry, but that’s exactly what we’re going to do: our reasoning is that macroeconomic conditions elsewhere on the continent are more comparable to those in the UK than those in the US.

On this basis, we compared the average 30-year gilt/bund spreads from 2022 until July 7 (when Boris Johnson announced he would step down) with the following period. Ideally, the pre-BoJo exit gap was almost exactly one percentage point:

Line chart of the 30-year gilt/bund spread showing the rise of the MRP

Let’s assume (as our early charts indicate) that, from a market perspective, Johnson wasn’t seen as a moron. This percentage point can be viewed broadly as encompassing a range of generalized factors that make the UK a less attractive place to buy debt than Germany. We will call it the UK Risk Premium or UKRP.

Taking that away from the spread, we can see MRP slipping over the summer and then going super saiyan last month:

Line graph of (return of gilts[minus]dam performance)[minus]UKRP = MRP indicating Moron risk premium

This formula is robust enough for our purposes although, for reasons related to protecting the sanity of the chartmaker, we have limited the view to end-of-day prices. Takeaway: Looking at the pre-MPC period from September 5-21, the Truss administration made a base MRP of about 70 basis points.

In the spirit of r-star, we’ll call it T-star.

Here is the daily MRP change with annotations for key events:

Column chart of changes in MRP have been particularly large since late September showing swing time

Unfortunately, news and markets don’t move in 24-hour shifts. Take the chancellor’s defenestration: although the actual sacking took place on Friday, October 14, it was pretty clear a day before Kwarteng’s bread was toast. And, on release day, the big move didn’t happen until after Truss left. terrible press conference.

However, in bold lines:

  • The fiscal/mini-budget event was worth about 1 percentage point of MRP. (We are assuming that the moves from September 23-27 were event-driven rather than BOE-related – which is not a consensus opinionalthough the timing of the movements seems to support this reading.)

  • The Bank’s intervention was equivalent to a reduction of 1 percentage point in the MRP

  • Kwarteng’s sacking assumptions equaled minus 0.2 percentage points of MRP, so one “kwarteng” is about 20 basis points

Let’s put this into practice. Tuesday we were still -1 supposed de-kwartengs. Gilt yields are falling over the long term today, suggesting that we may be closing in on the T-star. Analysts call it a “sticky moron bounty.”

Lyn Graham-Taylor, senior rate strategist at Rabobank, told FT Alphaville:

It is not permanent. But it’s probably a little more complicated than being tied down to Liz Truss alone. There’s probably a few other things in there, like how is this going to play out? Who will be the next Conservative leader? What policies will they have? What are the prospects for the next elections, etc., etc.? I think investors have relatively short memories of how long they’ve valued these things.

Getting to the details, how much does a kwarteng cost?

The Office for Budget Responsibility’s ready-to-use calculator suggests that from 2022/23 each additional percentage point on state rates would cost £16.8bn over the medium term (that’s i.e. half a decade):

©OBR / Barclays

Applying this formula, the amount of additional expenditure in real terms incurred by the tax event is approximately £16.8 billion. A kwarteng costs £3.4 billion a year over a typical five-year parliament.

After T-star, if Liz Truss was prime minister for the next half-decade it would cost the country £11.8billion, or almost £2.4billion a year, or £6.4million sterling per day. (It doesn’t quite match, but you get the idea.)

Act III: Red October for hunting

MRP is a fun notional concept. Governing through misguided incompetence has many consequences, but if that government is soft on deficits, what difference in cycle is a few extra billions a year?

Unfortunately for the British people, the Chancellor is now Jeremy Hunt, a very serious adult politician who will sort this all out.

In the absurd world of obsessive balancing act that is austerity, £11.8bn / £2.4bn a year MRP T-star is rather more worrying! Barclays analysts believe Hunt is likely to announce a further £30bn in cuts – the FTAV calculation would suggest much of this could be found simply by scrapping the silly risk premium.

Looking at it another way, here are via Barclays / the Institute for Fiscal Studies some examples of other things Hunt might consider for reductions:

Following this approach, the removal of the MRP T-star would result in savings equivalent to a 5% reduction in public service expenditure. The first path is more likely than the second to be a vote winner. After all, public service spending cuts affect a lot of people, while Liz Truss is unique.

As mentioned above, it’s not clear that Truss herself is the problem here, but given the occasion, it seems like taking her out is potentially a fiscally prudent move, and Hunt should definitely take that into consideration. when developing its spending plans.

In other words: