This news item may have gotten lost in the shuffle recently, but changes in global interest rates are starting to catch the attention of the financial community. Rightly so.
After a prolonged period of ultra-low interest rate policy in the United States, the nation's central bank has been slowly raising rates to reflect growing strength in the underlying economy.
The trick for central bankers is to find just the right balance between supporting growth and avoiding over-exuberance. Because when an economy strengthens, and interest rates are too low, loan growth can increase rapidly and catalyze unwanted inflation (aka a rapid increase in the prices of goods and services).
Due to the ongoing policies of the central bank in the United States, as well as a myriad of other global economic factors, the cost of borrowing typically varies across the timeline of maturities. The chart of interest rates across various maturities is often referred to as the “yield curve,” and is utilized by many to interpret and forecast economic trends.
There’s also a diverse group of market participants that use the yield curve to hedge their portfolios as well as strategize around possible interest rate-related trading opportunities.
If you want to learn more about interest rates and trading the yield curve, a recent episode of Ryan & Beef is worth a few moments of your time. On this episode, our dynamic duo sets their sites on the yield curve, and in the process, help simplify how traders can express their market opinions using interest rate futures.
The reason that interest rates are getting so much attention presently is because the curve appears to be flattening. The shape of the yield curve is traditionally steepening, meaning that long-term interest rates are higher than short-term interest rates.
However, the yield curve can also be flat or inverted - the latter meaning that short-term rates are higher than long-term rates.
When the curve is flattening or threatening to invert, interest in this niche of the financial markets usually picks up, because inverted yield curves can often be a signal that an economic slowdown is on the horizon. At this time there's obviously no guarantee that will actually come to pass. It should also be noted that recessions don’t usually materialize until many months after the yield curve inverts - if at all.
Having said that, it’s easy to see why traders should monitor the yield curve for the foreseeable future, and potentially build up a playbook of tactics to leverage in the event a recession does materialize.
On this installment of their show, Ryan and Beef do a fantastic job of explaining the mechanics of several of the best-known interest rate trading structures. Keep in mind that interest rates are traditionally accessed using bond futures due to the inverse correlation between these products. When interest rates rise, bonds prices fall - and when interest rates decline, bond prices increase.
If a trader has a view on the changing shape of the yield curve, he/she can express that opinion through bond futures. For example, if you believed that short term interest rates were going to rise, the corresponding position would be to sell short-term bond futures. Because as short term interest rates rise, short-term bond prices should theoretically decline.
On the show, you’ll notice that Ryan and Beef refer to short and long term bond futures using /ZT (2-year bond futures) and /ZN (10-year bond futures). A complete review of The Ryan & Beef Show focusing on the yield curve should help reinforce all of these concepts.
If you have any outstanding questions on trading interest rates, we hope you'll reach out by leaving a message in the space below, or sending Ryan and Beef a message at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.