What Is a Curve Steepener Trade?
A curve steepener trade is a strategy that uses derivatives to benefit from escalating yield differences that occur as a result of increases in the yield curve between two Treasury bonds of different maturities. This strategy can be effective in certain macroeconomic scenarios in which the price of the longer-term Treasury is driven down.
Key Takeaways
- Curve steepener trades benefit from rising yield differences as a result of an increase in the yield curve of two T-bonds of different maturities.
- A yield curve is a graph of the bond yield of various maturities.
- If the yield curve steepens, this means that the spread between long- and short-term interest rates increases—i.e. yields on long-term bonds are rising faster than yields on short-term bonds.
- A steepening yield curve indicates that investors expect stronger economic growth and higher inflation, leading to higher interest rates.
- The curve steepener trade involves an investor buying short-term Treasuries and shorting longer-term Treasuries.
Understanding Curve Steepener Trades
The yield curve is a graph showing the bond yields of various maturities ranging from 3-month T-bills to 30-year T-bonds. The graph is plotted with interest rates on the y-axis and the increasing time durations on the x-axis. Since short-term bonds typically have lower yields than longer-term bonds, the curve slopes upwards from the bottom left to the right. This is a normal or positive yield curve.
Sometimes, the yield curve may be inverted or negative, meaning that short-term Treasury yields are higher than long-term yields. When there is little or no difference between the short-term and long-term yields, a flat curve ensues.
The difference between the short-term and long-term yield is known as the yield spread. If the yield curve steepens, this means that the spread between long- and short-term interest rates increases. In other words, the yields on long-term bonds are rising faster than yields on short-term bonds, or short-term bond yields are falling as long-term bond yields are rising. When the yield curve is steep, banks are able to borrow money at a lower interest rate and lend at a higher interest rate.
An example of an instance where the yield curve appears steeper can be seen in a two-year note with a 1.5% yield and a 20-year bond with a 3.5% bond. The spread on both Treasuries is 200 basis points. If after a month, both Treasury yields increase to 1.55% and 3.65%, respectively, the spread increases to 210 basis points.
How and When to Use a Curve Steepener Trade
A steepening yield curve indicates that investors expect stronger economic growth and higher inflation, leading to higher interest rates. Traders and investors can, therefore, take advantage of the steepening curve by entering into a curve steepener trade.
The curve steepener trade involves an investor buying short-term Treasuries and shorting longer-term Treasuries. The strategy uses derivatives to hedge against a widening yield curve. For example, an individual could employ a curve steepener trade by using derivatives to buy five-year Treasuries and short 10-year Treasuries.
One macroeconomic scenario in which using a curve steepener trade could be beneficial would be if the Fed decides to significantly lower the interest rate, which could weaken the U.S. dollar and cause foreign central banks to stop buying the longer-term Treasury.
This decrease in demand for the longer-term Treasury should cause its price to fall, causing its yield to increase; the greater the yield difference, the more profitable the curve steepener trade strategy becomes.
What Is the Difference Between a Bullish and Bearish Steepener?
A bear steepener is utilized when the market is expected to experience increased inflation and, therefore, an increase in interest rates by the Fed to stem inflation. Bull steepeners are the opposite, utilized when interest rates drop and the market is expected to grow.
What Is the Difference Between a Flat and Steep Yield Curve?
A normal yield curve shows increasing yields with increasing maturity. A flat yield curve would show similar yields across all maturities, which indicates economic uncertainty. A steep yield curve is a signal of very strong economic growth, which would usher in increased inflation and higher interest rates.
How Do You Trade a Bull Steepener?
To trade a bull steepener you would buy short-term bonds and sell long-term bonds. When the difference between short- and long-term interest rates widens, you would earn more money on the short-term bonds than the money lost on the long-term bonds.
The Bottom Line
Traders can take advantage of the curve steepener strategy by using derivatives on two T-bonds of different maturities. When there are shifts in the economy, there are opportunities to make a profit. Traders would implement a curve steepener when there are macroeconomic events that will stimulate the economy with the expectation of inflation.
FAQs
The curve steepener trade is a strategy that involves simultaneously buying long-dated bonds and shorting short-dated bonds. The idea behind this trade is that if the yield curve steepens, meaning the difference between long and short-term yields increases, the trade will be profitable.
What is an example of a curve steepener trade? ›
The strategy uses derivatives to hedge against a widening yield curve. For example, an individual could employ a curve steepener trade by using derivatives to buy five-year Treasuries and short 10-year Treasuries.
What is a bear steepening strategy? ›
Bear steepener commonly occurs when investors are concerned about inflation or a bearish stock market in the short-term. Traders can take advantage of a bear steepener by going long (buying) short-term bonds and shorting (selling) long-term bonds.
What is Y curve trading strategy? ›
Riding the yield curve is a trading strategy that involves buying a long-term bond and selling it before it matures so as to profit from the declining yield that occurs over the life of a bond. Investors hope to achieve capital gains by employing this strategy.
What is the curve in trading? ›
Yield Curve Spread Trades, a.k.a curve trades1, provide market participants return generating and hedging opportunities. Curve trades occur in the most liquid interest rate markets including U.S. Treasuries, futures, other government bonds, swaps and euro-dollars.
What is a steepener in trading? ›
A steepener functions as an interest rate swap, which is a derivative contract between two parties wherein one agrees to pay the other a fixed interest rate in exchange for receiving a floating interest rate that is based on the difference between the long and short term rates.
How do steepener trades work? ›
A curve steepener trade uses derivatives to profit from rising yield differences due to yield curve increases between T-bonds of differing maturities. A bull flattener is a yield-rate environment in which long-term rates are decreasing at a rate faster than short-term rates.
What is a bull steepening? ›
A bull steepener occurs when bond prices are rising, and rising faster in the short-term part of the yield curve, sending yields down faster in the short-end. The classic bull steepener in the late stages of the monetary policy cycle occurs when the Fed cuts rates, bringing short-term rates down.
What is bear steepening and bull steepening? ›
A steepening yield curve is when the spread between long- and short-term bond yields widens. Either the long-term yield rises faster than the short-term yield - a bear steepener - or the short-term yield is falling more - a bull steepener.
What is bear flattening vs bull steepening? ›
Late 2021/early 2022 are a great example of bear flattening of the yield curve. Bull Steepener - When short term interest rates fall faster than long term interest rates (i.e. the 2 year treasury yield falling faster than the 10 year treasury yield).
The curve Steepener trade is a popular strategy used by investors to capitalize on interest rate shifts. Essentially, it involves taking a long position on long-term bonds while simultaneously taking a short position on short-term bonds.
How to trade a steepening yield curve? ›
If you expect the yield curve to steepen, you typically want to buy the spread. If you expect the yield curve to flatten, you will want to sell the spread. You buy or sell a yield curve spread in terms of what you do on the short maturity leg of the trade.
What is the difference between curve flattener and steepener? ›
Yield curve steepeners seek to gain from a greater spread between short- and long-term yields-to-maturity by combining a “long” short-dated bond position with a “short” long-dated bond position, while a flattener involves sale of short-term bonds and purchase of long-term bonds.
What are the 4 curve types? ›
Thus, a curve is a set of points that looks like a straight line that falls between two adjacent points. Question 3: What are the types of curves? Answer: The different types of curves are Simple curve, Closed curve, Simple closed curve, Algebraic and Transcendental Curve.
What is curve formula? ›
A curve can be represented in a graph using the help of equations. Let's understand it with the help of some examples. The equation y = x2 represents a parabola in the cartesian plane, as shown below. The equation ax2 + by2 = c is the general equation for an ellipse.
How to buy trade curve? ›
- Navigate to buy Curve DAO Token with USD page on Binance.
- Select Curve DAO Token and USD from the dropdown menu.
- Choose either "Google Pay" or "Apple Pay" as your payment method and press "Confirm".
- Click the "Buy " button.
- On the payment confirmation page, verify details and confirm the order within the time limit.
When the yield curve is steep, banks are able to borrow money at lower interest rates and lend at higher interest rates. An example of a steepening yield curve can be seen in a 2-year note with a 1.5% yield and a 20-year bond with a 3.5% yield.
What is the US curve steepener? ›
The Amundi US Curve Steepening 2-10 UCITS ETF - Acc is a UCITS compliant exchange traded fund that aims to track the Solactive USD Daily (x7) Steepener 2-10 Index. The index tracks the investment performance of a systematic strategy whose returns are directly linked to changes in the US treasury yield curve.
What are two examples of curve? ›
Circles, ellipses, parabolas, and hyperbolas, as well as arcs, sectors and segments, are two-dimensional curved shapes. Whereas, shapes such as spheres, cylinders and cones, are referred to as three-dimensional curved shapes.
What does a steeper yield curve mean? ›
A steep yield curve looks like a normal yield curve but with a steeper slope. Market conditions are similar for normal and steep yield curves. But a steeper curve suggests investors expect better market conditions to prevail over the longer term, which widens the difference between short-term and long-term yields.
