A curve steepener trade is basically a strategy to take advantage of an anticipated widening yield spread between short and long maturities, most often with U.S. Treasuries.
In most normal circumstances, interest rates increase with longer maturities. For example, a 5-year TSY bond that has a 3.0% yield, and a 30-year TSY bond with a 4% yield, have a 100 basis point spread as a norm. Should new reports indicate more positive business with potential inflation as a result, short-term rates may go down and longer-term rates would increase. In our example, the 5-year bond may get stronger, with yield lowering to 2.85%, while long-term bonds may soften, and rates may increase, to 3.10%. The new spread would be anticipated as 125 basis points.
A curve steepener trade might attempt to profit here, even by shorting the 30-year and going long on the 5-year. This could be done via derivatives or swaps, or by trading the actual bonds, depending on liquidity and portfolio size.
The reason it's called a curve steepener trade is because the yield spread between a short- and long-term maturity bond can be depicted graphically as two curved lines. The curve steepens as the yield on the longer maturity increases, hence the reference to “curve steepener.”
Comic book collectors who speculate on certain milestone issues, which are announced to be limited run with multiple covers, will buy up those issues with covers by a more popular artist, and buy and resell the standard cover issues, or the ones by less acclaimed artists, on the premise that the popular artist’s cover issue will be harder to find in the future, and thus carry a higher collector’s premium. So anyone with issues from multiple cover issues should check their price guides. Collector’s premiums can help pay for your kid’s college...if you have the right kind of collection. No one cares about your huge aluminum foil ball display.
Related or Semi-related Video
Finance: What is the Difference Between ...133 Views
Finance, a la Shmoop. [title page]
What's the difference between normal, inverted, and flat yield curves, and what to they tell
us?
All right, well let's start with the basics.
Yield curve... ooh, sexy term. [guy talks about yield curves]
Say it a lot and people will think you know a lot about finance.... or that you're really [people are pretty impressed]
into slowing down while making gradual left turns. [pig thanks slow driver]
But in finance, a yield curve is just a graphic representation of bond yields, from "maturing [yield curves defined]
soon" to "not maturing for a really long time."
So here's a yield curve. [yield curve illustrated]
Note that the ticks on the bottom are time and, on the left--the vertical y-axis there--it's
percentage, or yield.
Well, this particular curve slopes oh-so-gently upward. [upward slope demonstrated]
You can see that bonds maturing in three months yield 2% and bonds maturing in 30 years yield
4.5%.
What does this say?
Well, it says that the debt markets believe that interest rates will be meaningfully higher [diagram explained]
in the future--like, more than double--and that, to some extent, there's risk in getting
those bonds paid off.
That is, money tangibly ready to be paid off in the next two months carries a lot less
investment risk than bonds three decades away. [roaches discuss bills]
Yeah, you never know, we could have this... [roaches watch nuclear destruction of world]
So this is a normal curve: Money near term yields less than money due far away.
Well, most of the time, this is how yield curves look.
But think about an era where the government is desperately fighting inflation and it raises [government fights inflation]
short-term borrowing rates massively. [rates increase]
Well this, in fact, happened in the 1970s when Vietnam's war economy, coupled with a [Vietnam War footage]
bunch of other elements, produced roaring inflation in the U.S.
So the Fed then raised short-term rates into the double digit zone, but most investors [rates increase]
believed that these very expensive short-term interest rates would stop people from borrowing
and buying stuff.
Think about your credit card charging you 25% a year in interest. [big credit card bill]
Ugh, that's a lot.
It'll make you think twice about putting that belly button ring set you saw at the mall
on your AmEx. [person doesn't buy belly button ring]
So when people stopped buying things on credit, well, they bought a lot less and the economy [tumbleweed in mall]
cooled, and then the Fed went ahead and lowered rates and the yield curve went back to normal. [rates decrease]
But for a while, the curve was inverted. [inverted curve demonstrated]
That is, is started with short-term rates very high, and then long-term rates were cheaper.
And as you might be able to guess, somewhere in the middle there, as the curves crossed
over, there was a short period where the yield curve was pretty flat. [flat yield curve demonstrated]
That is, the price of renting money is the same whether you're borrowing it for three
months or 30 years.
You know, that same 3.5% kind of rent.
Got it?
So now you've got curves, and you know how to use 'em. [pig admires curves]