Govt. bonds have had an outstanding year, and the longer maturity bonds with the most interest rates sensitivity have fared the best. Though there are a good number of pundits that would call bonds the new “bubble”, there are some good fundamental reasons for why bonds have rallied recently. Concern about the state of the global economy, a realization that the trend in inflation is currently down, and a Federal Reserve that will be forced into keeping short rates low for the foreseeable future are all good fundamental reasons bonds have performed so well year to date.
Despite the recent returns, one has to be skeptical and wary about how much more return can be squeezed out of government bonds if the economy doesn’t contract from here, especially when considering how much money has flowed into the bond market recently. One way to invest in fixed income without buying the bonds themselves is to enter into yield curve flattening and steepening trades. The steepness or flatness is simply the difference in yield between two different maturities on the yield curve. Currently the 3 year minus 2 year spread is quite flat, at .26 percentage points of spread between the two maturities. The 30 year minus 2 year spread is still very wide, with a difference of about 3.3 %. This may represent an opportunity for investors that want to bet that the long end of the curve will flatten, presumably driven by long rates dropping closer to short term yields that are being anchored by the Fed. Like all trades, there will be bets on both side of the equation, and that’s what makes a market. With new ETN’s available to invest in a flattening or a steepening yield curve, we now have another tool in the arsenal to invest in fixed income markets without buying the bonds themselves. With yields at these levels, another option is good news for fixed income investors!
