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A Bear Flattener

Posted by Larry Doyle on June 8, 2009 2:25 PM |

For those actively involved in financial markets, the term “bear flattener” is common knowledge. For those not actively involved in the markets, let’s quickly address this concept, what drives it, and what it may mean for the economy.

Let’s break the “bear flattener” into its component parts.

Bear: short for bearish, this term implies declining valuations or prices for whatever security or market sector is being analyzed.

Flattener: analysis of the U.S Treasury yield curve (or the yield curve for any market sector) is typically referenced in terms of whether the curve is flattening or steepening. Reflect back on Algebra II and the concept of slope. Yield curve analysis is all about the slope of the curve.

A flattening of the slope of the curve implies that rates for short maturities are rising faster than rates on longer maturies.  In a rising rate environment, bond prices are declining thus the flattening is a bear flattener. If rates were falling but short maturity rates were not falling as much as long maturities, then the flattening would be considered a “bull” flattener.

What does a bear flattener portend for the economy? Typically a bear flattener is an indication of an economic contraction. Why? The rise in rates is usually a function of an increase in rates by the Federal Reserve. Why would the Fed raise rates? To slow the economy, the pace of inflation/expected inflation, or a combination of the two.

Let’s quickly review today’s price action across the U.S. Treasury yield curve. For purposes of measuring the slope of the curve, market analysts typically look at the relative performance and changes in rates on the 2yr Treasury note and the 10yr Treasury note. In today’s price action:

2yr Treasury note has increased by 8 basis points to 1.38%

10yr Treasury note has increased by 3 basis points to 3.86

The 2/10 slope thus equates to 2.48% or 248 basis points. The curve has flattened by 5 basis points today.

Be mindful that although the curve has flattened today as well as the last week (the slope peaked at approximately 275 basis points), the curve started the year at a rather flat level of 1.52% (152 basis points).

A steepening curve is beneficial to financial companies and typically, though not always, indicates an improving economy. A steepening curve can also be a harbinger of inflation as the increase in long term rates is a sign that inflation is likely to increase.

A flattening curve is typically an indication of a slowing economy and is definitely not beneficial to financial companies as funding costs increase.

As evidenced in my initial post this morning, Bernanke Conundrum, the market will often adjust interest rates and bond prices well before the Fed actually changes interest rates and Fed policy.

Thus, despite what market analysts or government officials may say, the slope of the yield curve speaks volumes.

Why don’t you engage your better half this evening with, “Did you see that bear flattener today?” Who knows, it may take your relationship into an entirely new realm as you navigate the economic landscape!!

LD






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