What is Bear Steepener
A bear steepener is the widening of the yield curve caused by long-term rates increasing at a faster rate than short-term rates. This causes a larger spread between the two rates as the long-term rate moves further away from the short-term rate.
BREAKING DOWN Bear Steepener
The yield curve is a graph that plots the yields of similar-quality bonds against their maturities, ranging from shortest to longest. Typically used in reference to US Treasury securities, the yield curve shows the yields of bonds with maturities ranging from 3 months to 30 years. In a normal interest rate environment, the curve slopes upward from left to right, indicating a normal yield curve. A normal yield curve is one in which bonds with short-term maturities have lower yields than bonds with long-term maturities. The short end of the yield curve based on short-term interest rates is determined by expectations for the Federal Reserve policy; it rises when the Fed is expected to raise rates and falls when interest rates are expected to be cut. The long end of the yield curve is influenced by factors such as the outlook on inflation, investor demand and supply, economic growth, institutional investors trading large blocks of fixed-income securities, etc.
The changes in the short-term or long-term interest rates leads to a flattening or steepening shape of the yield curve. When the shape of the curve flattens, this means that the spread between long-term rates and short-term rates is narrowing. This tends to occur when short-term interest rates are rising faster than long-term yields, or to put another way, when long-term rates are decreasing faster than short-term interest rates. On the other hand, the yield curve steepens when the spread between short- and long-term yields widens.
A steepening yield curve can either be a bull steepener or a bear steepener. A bull steepener is characterized by short-term rates falling faster than long-term rates. A bear steepener tends to occur when interest rates on long-term bonds are rising faster than rates on short-term bonds, leading to a widening of the difference between both yields. This widening yield curve is similar to a bull steepener except with a bear steepener this is driven by the changes in long-term rates, compared to a bull steepener where short-term rates have a greater effect on the yield curve. For example, when 10-year yields rise faster than 2-year yields, a bear steepening yield curve occurs.
Let’s look at an example in detail. Say bond yields on February 15 for 10-year and 2-year Treasury notes are 2.90% and 2.19%, respectively. The spread between both yields at this time is 2.90% - 2.19% = 71 basis points. Two months later, the bond yields for both securities have gone up to 3.25% and 2.22%, respectively. The spread is now 3.25% - 2.22% = 103 basis points.
If traders and investor start to worry about inflation and greater government borrowing, it is likely longer-term interest rates will rise more than interest rates on short-dated bonds. A bear steepener also occurs when investors are pessimistic or bearish about stock prices over the short-term. Remember that there is an inverse relationship between bond prices and yield, that is, when prices go down, the bond yield goes up, and vice versa. A bond trader can take advantage of a widening spread brought about by a bear steepener by going long short-term bonds and shorting long-term bonds, creating a net short position. As yields increase and the spread widens, the trader would earn more on the short-term bonds purchased than s/he would lose on the long-term bonds shorted.