Flat Yield Curve

What Is the 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 a similar credit quality. This type of yield curve flattening is much of the time seen during changes among normal and inverted curves. The difference between a flat yield curve and a normal yield curve is that a normal yield curve slants up.

Understanding the Flat Yield Curve

At the point when short and long-term bonds offer equivalent yields, there is generally little benefit in holding the longer-term instrument; the investor gains no excess compensation for the risks associated with holding longer-term securities. Assuming the yield curve is flattening, it demonstrates the yield spread between long-term and short-term bonds is decreasing. For instance, a flat yield curve on U.S. Treasury bonds is one in which the yield on a two-year bond is 5% and the yield on a 30-year bond is 5.1%.

A flattening yield curve might be a consequence of long-term interest rates falling more than short-term interest rates or short-term rates expanding more than long-term rates. A flat yield curve is regularly an indication that investors and traders are stressed over the macroeconomic outlook. One explanation the yield curve might flatten is market participants might be anticipating that inflation should diminish or the Federal Reserve to raise the federal funds rate in the close to term.

For instance, in the event that the Federal Reserve increases its short-term target over a predefined period, long-term interest rates might stay stable or rise. In any case, short-term interest rates would rise. Subsequently, the slant of the yield curve would flatten as short-term rates increase more than long-term rates.

Special Consideration: The Barbell Strategy

The barbell strategy might benefit investors in a flattening yield curve environment or on the other hand on the off chance that the Federal Reserve is hoping to raise the federal funds rate. Notwithstanding, the barbell strategy might underperform when the yield curve steepens. The barbell strategy is an investment strategy that could be utilized in fixed-income investing and trading. In a barbell strategy, half of a portfolio is comprised of long-term bonds, while the rest is comprised of short-term bonds.

For instance, expect the yield spread is 8%, and an investor accepts the yield curve will flatten. The investor could apportion half of the fixed-income portfolio to U.S. Treasury 10-year notes and the other half to U.S. Treasury two-year notes. In this way, the investor has some flexibility and could respond to changes in the bond markets. Be that as it may, the portfolio might experience a huge fall in the event that there is a fleeting increase in long-term rates, which is due to the duration of long-term bonds.

Features

• Such a curve can be viewed as a mental marker, one that could mean investors are losing faith in a long-term market's growth potential.
• One method for combatting a flattening yield curve is to utilize what's called a Barbell strategy, adjusting a portfolio between long-term and short-term bonds. This strategy works best when the bonds are "laddered," or staggered at certain stretches.
• A flattening yield curve is when short-term and long-terms bonds see no perceptible change in rates. This makes long-term bonds less appealing to investors.