Loading the player...

What is the 'Flat Yield Curve'

The flat yield curve is a yield curve in which there is little difference between short-term and long-term rates for bonds of the same credit quality. This type of yield curve is often seen during transitions between normal and inverted curves. The difference between a flat yield curve and a normal yield curve is a normal yield curve slopes upward.

BREAKING DOWN 'Flat Yield Curve'

When short and long-term bonds offer equivalent yields, there is usually little benefit in holding the longer-term instrument; the investor does not gain any excess compensation for the risks associated with holding longer-term securities. If the yield curve is flattening, it indicates the yield spread between long term and short term is decreasing. For example, a flat yield curve on U.S. Treasury bonds is one in which the yield on a two-year bond is 5% and the yield on a 30-year bond is 5.1%.

Reasons for a Flattening Curve

A flattening yield curve may be a result of long-term interest rates falling more than short-term interest rates or short-term rates increasing more than long-term rates. A flat yield curve is typically an indication investors and traders are worried about the macroeconomic outlook. One reason the yield curve may flatten is market participants may be expecting inflation to decrease or the Federal Reserve to raise the federal funds rate in the near term.

For example, if the Federal Reserve increases its short-term target over a specified period, long-term interest rates may remain stable or rise. However, short-term interest rates would rise. Consequently, the slope of the yield curve would flatten as short-term rates increase more than long-term rates.

Barbell Strategy for Flattening Yield Curve

The barbell strategy may benefit investors in a flattening yield curve environment or if the Federal Reserve is looking to raise the federal funds rate. However, the barbell strategy may underperform when the yield curve steepens. The barbell strategy is an investment strategy that could be used in fixed-income investing and trading. In a barbell strategy, half of a portfolio is comprised of long-term bonds, while the rest is comprised of short-term bonds.

For example, assume the yield spread is 8% and an investor believes the yield curve will flatten. The investor could allocate half of the fixed-income portfolio to U.S. Treasury 10-year notes and the other half to U.S. Treasury two-year notes. Therefore, the investor has flexibility and could react to changes in the bond markets. However, the portfolio may experience a significant fall if there is a meteoric increase in long-term rates, which is due to the duration of long-term bonds.

RELATED TERMS
  1. Term Structure Of Interest Rates

    The term structure of interest rates is the relationship between ...
  2. Riding the Yield Curve

    Riding the Yield Curve is a trading strategy that involves buying ...
  3. Inverted Yield Curve

    An inverted yield curve is the interest rate environment in which ...
  4. Yield Elbow

    The point on the yield curve indicating the year in which the ...
  5. Positive Butterfly

    A positive butterfly is a non-parallel yield curve shift in which ...
  6. Treasury Note

    A treasury note is a marketable U.S. government debt security ...
Related Articles
  1. Investing

    Interest Rates and Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  2. Investing

    One Thing The Yield Curve Says About Stocks

    Contrary to media hype, a flattening yield curve does not mean a recession is coming soon.
  3. Insights

    U.S. Recession Without a Yield Curve Warning?

    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
  4. Insights

    Four Scenarios: Fed Policy, the Yield Curve and Recessions

    If you were to compile a list of the most effective recession predictors, the term spread, or difference between short and long-term interest rates, would likely be at the top of that list.
  5. Investing

    Understanding Interest Rates, Inflation And Bonds

    Get to know the relationships that determine a bond's price and its payout.
  6. Investing

    Regional Banks Face Strong Headwinds (CBF, FITB)

    While regional banks managed profit growth, they are facing strong head winds from a flattening yield curve and slower commercial loan growth.
  7. Investing

    How Rising Interest Rates and Inflation Affect Bonds

    Understand bonds better with these four basic factors.
  8. Investing

    The barbell investment strategy

    The barbell strategy is standard conventional wisdom offered regarding modern portfolio theory, to strike an acceptable balance between risk and reward.
  9. Investing

    Why Surging Bond Yields Won’t Kill the Bull Market

    Yields are rising for all the right reasons and that is a positive for earnings and stock prices.
  10. Insights

    Bank Stocks Set to Shine as Fed Tapering Begins

    As the Fed embarks on a monumental shift in policy, Goldman Sachs sees value in financials.
RELATED FAQS
  1. What is the difference between term structure and a yield curve?

    Understand the difference between the term structure of interest rates and a yield curve, if any. Learn what the yield curve ... Read Answer >>
  2. What is the current yield curve and why is it important?

    Understand what the current yield curve represents, and learn how market analysts commonly interpret various changes in the ... Read Answer >>
  3. How can I create a yield curve in Excel?

    Yield curves indicate where future interest rates are headed and you can actually make one in excel. Find out more about ... Read Answer >>
  4. Which economic factors impact treasury yields?

    Discover the economic factors that impact Treasury yields. Treasury yields are the benchmark yield for the rest of the world, ... Read Answer >>
Hot Definitions
  1. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  2. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  6. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
Trading Center