If it is believed that the yield curve is going to steepen very soon, it may be fall in short-term rates, a rise in long-term rates, or some combination of these. What strategy should you pursue in the bond market to position ourselves to profit from our beliefs? Does it relate to the concept of curve twisting or parallel shifting? Thanks.
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2This question is pretty broad and subject to a lot of personal opinion. Any chance that you can refine it to something more narrow? You risk getting closed as it stands now.– user32479Commented Feb 4, 2016 at 16:27
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2 Answers
A steep yield curve generally means that inflation expectations are rising or there is great uncertainty of the future, as it implies that people are either (1) reluctant to buy longer term bonds, or (2) are are keeping their funds liquid because they feel uncertain about the future. You can check Chinese bonds and see inverted expectations as their 30 year to 5 year difference is less than 1 (by contrast the US is close to 1.5).
It's important to separate what inflation is reported as and how people are responding. Inflation may appear to be low according to every source you check, yet people don't perceive this because they may be seeing higher bills, housing costs, or other costs for their life. These people - "the market" - may be unwilling to buy longer term bonds because they know those won't keep up with the costs they're facing, so they either park their money in a short term place for immediate access, or they invest in something they think will do well over the long run.
We can apply the same paragraph to uncertainty - what you may hear about "economic certainty" may not be mirrored in the market because on an individual level, people don't feel that way. I liken this to statistics about employment, yet the amount of people who say that they aren't working the hours they want, or making the money they want either. How accurate are these employment statistics, especially when we relate them to what people need (I don't know the answer).
As for what makes the best investment strategy during uncertainty or inflation? That's a very difficult question to answer, because historically, different things have offered advantages in these periods. Generally, commodity baskets tend to do well as well as taking advantage of immediate and future needs that don't expire.
answered Feb 4, 2016 at 18:07
Expectations for a steepening yield curve typically requires a bullet strategy focused on intermediate-term rates. You lose some gain in the short rates, but protect against a greater loss in the long rates; that is, the long loss is greater because duration for long-maturity securities is greater. Duration is the percentage change in price for a given percentage change in yield required by the market.
