Interest Rate Yield Curve
The interest rate yield curve is a staple of all investing, quite similar to the old crop/new crop spread in the grains. The concept is simple to trade. The interest rate yields for bond and note products, with the equivalent rating but different maturity dates, should be at different levels. The rule of thumb is that the longer the money is lent out the more interest should be paid; this is commonly referred to as the "normal yield curve ." This normal yield curve is designed to ensure that the 30 year U.S. Treasury Bond has a greater yield than the 5 and 10 year Treasury Notes because there is more risk associated with the length of time.
The interest rate yield curve has a direct impact on how mortgage rates are set, bank lending practices, and credit cards. The interest rate yield curve also has a predictive component. A normal yield curve is indicative of a solid economy and positive growth. Any change in the yield curve away from normal can portend a significant adjustment in the economy.
The Federal Reserve's policies for the U.S. economy and the U.S. government's desire for either a weak or strong currency also play a significant role in what interest yields are being offered to the public. In the blink of an eye interest rates can move from a normal yield to an inverted yield; this is when near-term notes command higher interest rates than long-term bonds . The inverted yield can indicate whether a country's economy is faced with the potential of a recession.
A flat market occurs when short-term interest rates and long-term interest rates match up in value. A flat market can be worse than a normal or inverted yield solely because of the level of uncertainty that it represents. Either interest rates can cooperate and become normal or there may be a sudden drop in value with long-term interest rates forcing an inverted market on the public.
In order to effectively trade the yield curve most traders have one of two choices. They can actually purchase and sell the associated short-term notes and long-term bonds or they can trade in the futures markets. If the yield curve is traded in the futures market then the issues associated with leveraged trading will also have an impact on how a retail trader approaches this spread opportunity.
