Bear steepener is visible on chart showing yield curve. It is a widening spread between long-term and short-term rates. The yield curve presents yields of the bonds of similar quality against their maturities. In normal situation the curve slopes upward. In such situation bonds with short-term maturities have lower yields than long-term ones. That is called normal yield curve. If investors start to worry about inflation it is possible that long-term interest rates will rise more than interest rates on short-term bonds. A bear steepener also occurs when investors are pessimistic or afraid about stock prices in the short-term, because there is an inverse relationship between bond prices and yield. When prices go down, the bond yield goes up.
A yield curve is a line which shows the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. Yield curve compares the most often the three-month, two-year, five-year, 10-year and 30-year U.S. Treasury debt. It is used as a benchmark for other debt in the market for example: bank lending rates and is used as a prognostic of economy changes or growth. The short end of yield curve depends on short-terms interests rates. It depends of the Federal Reserve policy. When Fed expect to raise rates then the yield curve rise up. In other way it goes down. The long end of yield curve depends on investor demand and supply, economic growth and other similar situations.
Types of yield curve
We have 4 types of yield curve depending on economic situation:
- Bear steepener happens when interest rates on long-term bonds are rising faster than rates on short-term bonds. The change is driven by long-term bonds.The bear steepener happens when increase of inflation is predicted or investors are pessimistic about the stock prices.
- Bull steepener happens when the interest rates on short-term bonds are falling faster than rates on long-term bonds. the change is driven by short-term bonds. The bull steepener happens when the Fed is expected to lower interest rates.
- Bear flattener happens when short-term interest rates are rising faster than long-term rates. This change in the yield curve often precedes the Fed raising short term interest rates, which is bad for the economy and also for the stock market.
- Bull flattener happens when long term interest rates are falling faster than short term interest rates. This can often happen because of a flight to safety trade and/or a lowering of inflation expectations.
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- Konstantinov, G. (2016). Capturing short-term and long-term alpha of global bond portfolios: evidence from EUR-investors’ perspective. Financial Markets and Portfolio Management, 30(3), 337-365.
- Tchuindjo, L. (2012). On valuing constant maturity swap spread derivatives. Journal of Mathematical Finance.
Author: Piotr Budz