Fixed Income Essentials
Convertible Notes
Bonds Fixed Income Essentials
Bull Flattener
Reviewed by James Chen
What Does Bull Flattener Mean?
A bull flattener is a yield-rate environment in which long-term rates are decreasing at a rate faster than short-term rates. This causes the yield curve to flatten as the short-term and long-term rates start to converge.
Understanding Bull Flattener
The yield curve is a graph that plots the yields of similar-quality bonds against their maturities, ranging from shortest to longest. Typically made in reference to US Treasury securities, the yield curve shows the yields of bonds with maturities ranging from 3 months to 30 years. In a normal interest rate environment, the curve slopes upward from left to right. This shows that bonds with short-term maturities have lower yields than bonds with long-term maturities. The short end of the yield curve based on short-term interest rates is determined by expectations of the Federal Reserve policy concerning rates, rising when the Fed is expected to raise rates and falling when interest rates are expected to be cut. The long end of the yield curve is influenced by factors such as the outlook on inflation, investor demand and supply, economic growth, institutional investors trading large blocks of fixed-income securities, etc.
When the yield curve moves, it either steepens or flattens. When the yield curve steepens, the spread between the short-term and long-term interest rate widens, making the curve appear steeper. This occurs when interest rates on long-term bonds are rising faster than rates on short-term bonds. A flattening yield curve, on the other hand, occurs when the spread between long-term and short-term interest rates on bonds decrease. A flattener can either be a bear flattener or a bull flattener.
In a bear flattener, short-term interest rates rise faster than long-term interest rates, making the yield curve flatter. This change in the yield curve often precedes the Fed raising short term interest rates, which is bearish for both the economy and the stock market. Conversely, when the shape of the yield curve flattens as a result of long-term interest rates falling faster than short-term interest rates, this movement is referred to as a bull flattener.
Explaining the concept another way, when the yields on long-dated bonds fall more quickly than interest rates on short-term bonds, eventually, both interest rates start to converge. The convergence, in turn, flattens the yield curve when plotted on a graph. For example, on February 9 the two-year note is at 2.07% and the 10-year at 2.85%. On March 10, the two-year note yields 2.05% while the 10-year yields 2.35%. The difference went from 78 basis points to 30 basis points, led by a steeper fall in the 10-year note by 50 basis points, leading to a flatter yield curve.
The bull flattener is used as a bullish indicator of the economy. It could indicate that investors expect stocks in the capital market to rise in the short term, leading to comparatively higher short-term rates. A bull flattener could also occur as more investors choose long-term bonds relative to short-term bonds, which drives long-term bond prices up and reduces yields. The change in the yield curve often precedes the Fed lowering short term interest rates, which is bullish for both the economy and the stock market. Bond traders study the yield curve and trade the spread between long term bonds and short term bonds in order to profit from the difference between the two rates.
Bear Flattener
Bear flattener is a yield-rate environment in which short-term interest rates are increasing at a faster rate than long-term interest rates.
What is Yield Curve Risk?
The yield curve risk is the risk of experiencing an adverse shift in market interest rates associated with investing in a fixed income instrument.
Curve Steepener Trade
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.
Bull Steepener
A bull steepener is a change in the yield curve caused by short-term rates falling faster than long-term rates, resulting in a higher spread between the two rates.
Flat Yield Curve
The flat yield curve is a yield curve in which there is little difference between short-term and long-term rates for bonds of the same credit quality.
Bear Steepener
A bear steepener is the widening of the yield curve caused by long-term rates increasing at a faster rate than short-term rates. This causes a larger spread between the two rates as the long-term rate moves further away from the short-term rate.
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