Bull Steepener: Making Sense of This Shift in The Yield Curve

What Is a Bull Steepener?

A bull steepener is a change in the yield curve caused by short-term interest rates falling faster than long-term rates, resulting in a higher spread between the two rates. A bull steepener can be contrasted with a bull flattener or bear steepener.

Understanding Bull Steepeners

A bull steepener occurs when the Fed Reserve is expected to lower interest rates. This expectation causes consumers and investors to become optimistic about the economy and bullish about prices in the stock market over the short term.

The yield curve is a graph that plots the yields of similar-quality bonds against their maturities, ranging from shortest to longest. Typically made in reference to U.S. 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. This shows that 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, rising when the Fed is expected to raise rates and falling 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.

For example, if the yield on a 6-month T-bill was 1.94% and the yield on a 10-year note was 2.81%. The spread during this time would be 87 basis points, or (2.81% - 1.94%). A month later, the 6-month bill yields 1.71%, while the 10-year note yields 2.72%. The spread is now wider at 101 basis points (bp), or (2.72% - 1.71%), leading to a steeper yield curve. This widening of the spread between the two was caused by the short term rates falling more than the long term rates (23bp to 9bp)

Bull Steepener vs. Flattener

When short-term or long-term interest rates change, the yield curve either flattens or steepens. When the shape of the curve flattens, this means 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 put it 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 steepener differs from a flattener in that a steepener widens the yield curve while a flattener causes long-term and short-term rates to move closer together. A steepening yield curve can either be a bear steepener or a bull steepener. 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. Changes in long-term rates have a greater effect on the yield curve than changes in short-term rates.

A bull steepener is characterized by short-term rates falling faster than long-term rates, increasing the difference between short- and long-term yields. When the yield curve is said to be a bull steepener, it means that the higher spread is caused by the short-term rates, not long-term rates. When 2-year yields decline at a faster rate than 10-year yields, for example, a bull steepening yield curve occurs.