The 2y-10y Treasury Curve has inverted reaching negative 0.5%. Historically the curve never remains inverted for too long, and in the reversion to mean Value Equities and Treasuries tend to do well. Experienced traders should consider a curve steepener.
How to invest in Q4?
In conclusion we’re in a range-bound market driven by value. It is possible to make money in the next 12 months, but it will require a clear bent to value and the ability to sit in cash until the right moment.
A primer on the Curve Steepener: an elegant trade to protect against a recession
What follows is a complex trade that you should not attempt if you do not have a good grasp of fixed income investing.
When the curve inverts you can trade it in expectation its net yield will rise - which historically happens once the Fed “overdoes it” and we go into a recession.
To explain how this works, let’s first explain what “the curve” really is.
The curve is the spread in yield between the 2y and 10y Treasury. Using 2s and 10s is a common but arbitrary convention, and investors often look at other pairs of maturities like 2s5s or 10s30s.
Investors trade the curve in expectations it steepens or flattens - i.e. that the net yield goes up or down respectively.
To create a curve trade, investors account for the fact that the price of longer-maturity bonds moves more than that of short bonds for the same move in yield.
This is called “duration” and we won’t explain it now because if you don’t know what duration is you should NOT try a curve trade.
To structure a curve steepener you buy the 2s and sell the 10s. At today’s rates you would buy approx. $4.5 of 2y bonds for each $1 of 10y bonds you short.
We won’t bore you with the arithmetics but - currently - the net carry of a stepener is positive if implemented via futures.
Which means you can have a nice curve steepener in your pockets for the next 12 months with a) a fantastic inverted entry point and b) net positive carry. Basically you sit and wait to see if the recession comes or the curve naturally steepens. And you make money while you’re at it.
Curve trades are fun!
If you want to learn more, we suggest you read the riveting bestseller “The Handbook of Fixed Income Securities”, known colloquially as the Fabozzi.
Equity yield indicators for CVX:NYSE reached a recent high and historically, this led to a median increase in price of 9.36% over the following 1M. TOGGLE analyzed 4 similar occasions in the past to produce the median projection and this insight received 6 out of 8 stars in our quality assessment.
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