Note Against Bond Spread (NOB)

What Is a Note Against Bond Spread (NOB)?

A note against bond spread (NOB), also known as a note over bond spread, is a pairs trade created by taking offsetting positions in 30-year Treasury bond futures with positions in ten-year Treasury notes. Essentially, it is a bet on the relative yields of these respective debt instruments.

Understanding Notes Against Bond Spread (NOB)

The note against bond spread (NOB) or, as it is more commonly known, the note over bond spread allows futures traders to bet on expected changes in the yield curve, or the difference between long-term and short-term interest rates.

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, where the economy is expanding and investors are willing to take longer-term risks. 

Conversely, the yield curve tends to flatten when investors become more risk-averse, or when the economy is contracting. This can indicate economic weakness, as the market expects low rates of interest and inflation. In extreme cases, the yield curve may even invert, meaning that short-term notes temporarily pay higher yields than long-term bonds.

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

How to Trade a Note Against Bond Spread (NOB)

The Chicago Mercantile Exchange (CME) regularly publishes the hedge ratio, representing the relative yields of the treasury contracts that are needed to put on a NOB spread trade. A ratio of 2:1 suggests it takes two ten-year note contracts for each 30-year bond contract to put on the NOB trade.

A trader who expects the yield curve to flatten will sell a NOB spread. In this case, that means they will sell two contracts on ten-year notes, and buy a contract on the longer maturity, 30-year bond. If their trade is successful, the yields for the ten-year notes will increase at a faster rate than the yield on the 30-year bond. The value of the long-term bond will rise, relative to the price of the ten-year note.

Conversely, if a trader expects the yield curve to steepen, they will buy a NOB spread. This is done by buying the shorter maturity, ten-year notes, and selling the longer maturity, 30-year bond. This trader will make money if the 30-year bond yields increase at a faster rate than the ten-year note yields. The market price of the short-term notes will rise relative to the value of the bond.

Bond Spread as an Economic Indicator

The NOB spread is a useful indicator for market sentiment. If futures traders are overwhelmingly going short on the 30-year bond and long on the ten-year note, this is an indication that the prevailing market sentiment expects longer-term interest rates to rise.

Conversely, if traders are overwhelmingly going long on the 30-year bond and short on the ten-year note, it reflects their belief that longer-term market interest rates will fall.