What Is a Note Against Bond Spread (NOB)?

A note against bond spread (NOB) is a pairs trade created by taking offsetting positions in 30-year Treasury bond futures with positions in 10-year Treasury notes. Essentially, it is the difference between the yields of these respective debt instruments.

Key Takeaways

  • A note against bond spread (NOB) or, as it is more commonly known, a note over bond spread is a pairs trade created by taking offsetting positions in 30-year Treasury bond futures with positions in 10-year Treasury notes.
  • Buying or selling a NOB spread depends on whether the investor expects the yield curve to steepen or flatten.
  • Watching the NOB spread over time also provides a picture of where investors think longer-term market yields and the yield curve may be headed.

Understanding Note Against Bond Spread (NOB)

The note against bond spread (NOB) or, as it is more commonly known, the note over bond spread allows investors to bet on expected changes in the yield curve, or the difference between long-term rates and short-term rates. Watching the NOB spread over time also provides a picture of where investors think longer-term market yields and the yield curve may be headed.

Buying or selling a NOB spread depends on whether the investor expects the yield curve to steepen or flatten. The curve steepens when long-term rates rise more than short-term rates. This happens in most normal market conditions in which the economy is expanding and investors are willing to take longer-term risks. Conversely, a flattening of the yield curve, or yield curve inversion, happens when investors become more risk-averse, or when the economy is contracting.

Yields move inversely to bond prices. So, for example, weaker bond pricing results in higher yields. This is because bond issuers will have to offer a higher yield to compensate for the decease in market demand. Stronger bond pricing results in lower yields, because demand is high and investors require less compensation to buy bonds.

If an investor expects the yield curve to flatten, they will sell a NOB spread. They will do so by selling the shorter maturity, the 10-year note, and buying the longer maturity, the 30-year bond in the hopes that 10-year note yields will move higher at a faster rate than the 30-year bond yields.

Conversely, If an investor expects the yield curve to steepen, they will buy a NOB spread. This is done by buying the shorter maturity, the 10-year note, and selling the longer maturity, the 30-year bond, in the hopes that the 30-year bond yields will move higher at a faster rate than the 10-year mote yields.

The Chicago Mercantile Exchange (CME) regularly lists a ratio, known as the hedge ratio, of how many contracts are needed to put on a NOB spread trade. A ratio of 2:1 suggests it takes two 10-year note contracts for each 30-year bond contract to put on the trade. 

NOB Spreads and Interest Rates

As mentioned previously, it's also interesting to watch the NOB spread to get a sense where investors believe interest rates are headed. If investors are overwhelmingly going short on the 30-year bond and long on the 10-year note, it's an indication they think longer-term market interest rates will rise. Conversely, if investors are overwhelmingly going long on the 30-year bond and short on the 10-year note, it reflects their belief that longer-term market interest rates will fall.