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. Bull Flattener

    A bull flattener is a yield-rate environment in which long-term ...
  2. Normal Yield Curve

    The normal yield curve is a yield curve in which short-term debt ...
  3. Curve Steepener Trade

    Curve steepener trade is a strategy that uses derivatives to ...
  4. Yield Elbow

    A yield elbow is a point on the yield curve indicating the year ...
  5. Bull Steepener

    A bull steepener is a change in the yield curve caused by short-term ...
  6. On-The-Run Treasury Yield Curve

    The on-the-run Treasury yield curve is derived from on-the-run ...
Related Articles
  1. Investing

    Understanding Treasury Yield And Interest Rates

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

    Understanding The Treasury Yield Curve Rates

    Treasury yield curves are a leading indicator for the future state of the economy and interest rates.
  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. Investing

    Charles Schwab: Flattening Yield Curve Isn't Reason to Worry About Stocks

    While stock investors have plenty of worries, the flattening yield curve shouldn't be one of them, says Charles Schwab's Liz Ann Sonders.
  5. Investing

    Charles Schwab: Large-Cap Stocks Could Restart Their Outperformance

    Owing to a flattening of the yield curve, Charles Schwab said that large-cap stocks could outperform again.
  6. Insights

    Is a Recession in the Works? Ask an Inverted Yield Curve

    An inverted yield curve has predicted the last seven recessions. Is number eight around the corner?
  7. Investing

    3 Risks U.S. Bonds Face in 2016

    Learn about the major risks for the bond market in 2016; interest rate increases, high-yield bond volatility and a flatter yield curve may be issues.
  8. 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.
  9. Investing

    Understanding Interest Rates, Inflation And Bonds

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

    Some Like it Hot (The Economy, That is)

    We look at past market reactions as the Federal Reserve contemplates higher interest rates, and what the yield curve may be saying about stocks.
RELATED FAQS
  1. What does market segmentation theory assume about interest rates?

    Learn about how the market segmentation theory for different maturities of interest rates seeks to describe the shape of ... Read Answer >>
  2. 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 >>
  3. What economic factors influence corporate bond yields?

    Discover the economic factors that most influence corporate bond yields, which reflect the market's assessment of a company's ... Read Answer >>
  4. How can bond yield influence the stock market?

    Learn how bond yields influence the stock market. The relationship between bond yields and stocks changes depending on the ... Read Answer >>
Trading Center