Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
Palladium Surges above $2,400. Is It Sustainable? - 27th Jan 20
THIS ONE THING Will Tell Us When the Bubble Economy Is Bursting… - 27th Jan 20
Stock Market, Gold Black Swan Event Begins - 27th Jan 20
This Will Signal A Massive Gold Stocks Rally - 27th Jan 20
US Presidential Cycle Stock Market Trend Forecast 2020 - 27th Jan 20
Stock Market Correction Review - 26th Jan 20
The Wuhan Wipeout – Could It Happen? - 26th Jan 20
JOHNSON & JOHNSON (JNJ) Big Pharama AI Mega-trend Investing 2020 - 25th Jan 20
Experts See Opportunity in Ratios of Gold to Silver and Platinum - 25th Jan 20
Gold/Silver Ratio, SPX, Yield Curve and a Story to Tell - 25th Jan 20
Germany Starts War on Gold  - 25th Jan 20
Gold Mining Stocks Valuations - 25th Jan 20
Three Upside and One Downside Risk for Gold - 25th Jan 20
A Lesson About Gold – How Bullish Can It Be? - 24th Jan 20
Stock Market January 2018 Repeats in 2020 – Yikes! - 24th Jan 20
Gold Report from the Two Besieged Cities - 24th Jan 20
Stock Market Elliott Waves Trend Forecast 2020 - Video - 24th Jan 20
AMD Multi-cores vs INTEL Turbo Cores - Best Gaming CPUs 2020 - 3900x, 3950x, 9900K, or 9900KS - 24th Jan 20
Choosing the Best Garage Floor Containment Mats - 23rd Jan 20
Understanding the Benefits of Cannabis Tea - 23rd Jan 20
The Next Catalyst for Gold - 23rd Jan 20
5 Cyber-security considerations for 2020 - 23rd Jan 20
Car insurance: what the latest modifications could mean for your premiums - 23rd Jan 20
Junior Gold Mining Stocks Setting Up For Another Rally - 22nd Jan 20
Debt the Only 'Bubble' That Counts, Buy Gold and Silver! - 22nd Jan 20
AMAZON (AMZN) - Primary AI Tech Stock Investing 2020 and Beyond - Video - 21st Jan 20
What Do Fresh U.S. Economic Reports Imply for Gold? - 21st Jan 20
Corporate Earnings Setup Rally To Stock Market Peak - 21st Jan 20
Gold Price Trend Forecast 2020 - Part1 - 21st Jan 20
How to Write a Good Finance College Essay  - 21st Jan 20
Risks to Global Economy is Balanced: Stock Market upside limited short term - 20th Jan 20
How Digital Technology is Changing the Sports Betting Industry - 20th Jan 20
Is CEOs Reputation Management Essential? All You Must Know - 20th Jan 20
APPLE (AAPL) AI Tech Stocks Investing 2020 - 20th Jan 20
FOMO or FOPA or Au? - 20th Jan 20
Stock Market SP500 Kitchin Cycle Review - 20th Jan 20
Why Intel i7-4790k Devils Canyon CPU is STILL GOOD in 2020! - 20th Jan 20

Market Oracle FREE Newsletter

Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Play the Treasury Bond Market Yield Curve with New ETNs

Interest-Rates / US Bonds Aug 26, 2010 - 08:11 AM GMT

By: Ron_Rowland

Interest-Rates

Best Financial Markets Analysis ArticleMany individual investors spend their time thinking about stocks. Which stocks are going up? How high are they going? Should I buy now?

These can be important questions, but stocks aren’t the only financial market. So why do eyes glaze over when the bond news comes on? My guess is that people don’t understand how big the bond market is — or how much influence it has on everything else.


Today we’re going to talk about one aspect of bond trading and how exchange-traded products give you a new opportunity to play it. Let’s look at the …

Treasury Yield Curve

As you know, prevailing interest rates depend on many factors including the amount of time the borrower will need the money. For instance, if I loan you cash for a week, I have some assurance you’ll still be around and able to pay me when the loan comes due. If the loan is for thirty years, though, neither one of us can be certain what will happen.

In other words, longer-term loans carry more risk. Therefore, lenders want extra reward for taking on that extra risk.

This is why, under normal circumstances, long-term interest rates are higher than short-term rates. How much higher? It varies, and this is where the yield curve helps us. The yield curve is simply an illustration of current interest rates across the maturity spectrum.

Let’s look at an example of the yield curve using U.S. Treasury debt, which are essentially loans — you the investor are loaning the government your money. Here’s what it looked like as of Wednesday, August 25 …

chart1 Play the Yield Curve with New ETNs
The Treasury yield curve represents yields for different maturities.

The vertical axis is the current interest rate. The horizontal axis is time to maturity. As of this date, 30-day T-bills were at 0.16 percent, two-year T-notes were at 0.48 percent, ten-year notes were yielding 2.43 percent, and the thirty-year bond yield was 3.48 percent. Put all these on a graph and you get a nice, upward-sloping curve.

Now here is the important part: How steep is the curve? Even more important, is it getting steeper or flatter? This brings us to another graph, one that my Money and Markets colleague Mike Larson shared with you last week. It’s called the “2-10 Spread.”

This number as shown in the chart below is simply the current yield on ten-year Treasury securities minus the current yield on two-year Treasury paper.

chart2 Play the Yield Curve with New ETNs
The gap between short-term and long-term Treasury rates is dropping this year.

As you can see, earlier this year the 2-10 spread was up around 290 basis points (2.90 percent). Now it’s almost down to 200 bps. This is a massive move in a fairly short time.

That means the gap between the interest rate for ten-year money vs. two-year money is smaller than it was just a few months ago. Consequently, the yield curve is getting flatter.

This makes a huge difference to traders and especially to bankers since banks make their profits by borrowing short-term and lending long-term. They have a hard time when the yield curve is flatter than usual.

Yet with the Federal Reserve keeping short-term rates close to zero and private borrowers unwilling (or unable) to commit to long-term loans, the yield curve seems unlikely to steepen in the near future.

All is not lost, though …

The nice thing about financial markets is that whenever there is movement, there is also opportunity. However, until recently strategies to play the yield curve were only available to professional investors.

But now, thanks to the exchange-traded fund revolution, you have the potential to profit from changes in the yield curve, too.

In fact, Barclays just launched two new products that make it easy:

  • iPath U.S. Treasury Steepener ETN (STPP)
  • iPath U.S. Treasury Flattener ETN (FLAT)

STPP and FLAT try to capture changes in the 2-10 Treasury spread. When the spread goes up (i.e. the yield curve gets steeper), STPP is supposed to benefit. And when the spread gets smaller — meaning the yield curve is flattening — FLAT is designed to go up in value.

Note that neither of these products has anything to do with whether interest rates are falling or rising. What counts is the spread, or the distance, between two-year and ten-year yields. If the spread widens or narrows and you forecast the change correctly, you can make money no matter what interest rates do.

There Are Risks, Of Course …

STPP and FLAT are exchange-traded notes (ETNs), not ETFs. This means they are essentially a form of bond issued by a bank — Barclays, in this case. So ETN holders could be left holding the bag if Barclays defaults on its debts. You can read more about ETNs in this 2009 Money and Markets column.

Also be aware that no matter what you think about the yield curve, there is no point in owning both STPP and FLAT at the same time. Because their objectives are opposite, losses in one will probably cancel out any gains in the other.

As with any new ETF or ETN, liquidity is a concern so be sure to use limit orders if you decide to try them out.

Last but not least, these products are leveraged, which means both gains and losses will be magnified.

Am I recommending either STPP or FLAT right now? No. I write about them because I want you to see some innovative examples of how the investment world is changing. You have plenty of opportunities. ETFs and ETNs just make it easier to find them.

Best wishes,

Ron

P.S. If you didn’t see my appearance on the most recent Weiss Global Forum, you can now read the transcript online. Check it out!

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules