Pier 5 Condo

The Treasury yield curve is one of the best and most applicable tools that a global macro investor can have in his or her toolbox. Most of the time used for bond trading there are several applications for it in the stocks and currency market as well. The truth is by using the yield curve correctly you can better trade just about everything.

So what is the Treasury yield curve? It is the curve you get when you plot out the yields on different maturities of Treasury securities. For instance if you take the ninety day Treasury bill, the two year Treasury bill, five year Treasury note, ten year Treasury bond, and the thirty year Treasury bond you will get a curve. Usually sloping upwards from the bottom left to the upper right of the plot area, it can also take several other shapes. It can be very inverted with the far right down at the bottom and the far left at the top, it can have seemingly random lumps, and it can shift anywhere on the plot area. Each of these shapes and slopes of the yield curve tell the global macro investor something differently about the economy and the different trading instruments available to you.

This is great but how do you use it to make money? Well the global macro investor knows that if the curve is sloped from the lower left to the upper right that things are looking good for the economy. If on the other hand it is sloping downwards the Fed has tightened and the economy is or will be slowing.

So how does this help your trading? Well if the curve is steep then there is little chance that bonds will be able to stage a very robust rally. At the same time it might be a great time to go long stocks. If the curve is sloping down then it is a harbinger of things to come and the economy is ready to contract and therefore it is kind of a sell signal for stocks. At the same time if the curve is inverted then it is a great time to look at going long bonds as the Fed will likely begin a interest rate easing cycle and therefore driving up bond prices.

If money is expensive then the economy will have a hard time expanding. If money is expensive for banks then they will not lend very much as they are not making money off of it. If money is cheap then the economy can grow easier as banks will lend and businesses will borrow more to expand and to spend.

Bonds and rates are like a piece of wood straddled on a log. If you sit at one end the other end goes up. If bonds are at one end yields are at the other. When yields go down bonds go up and vice versa. This is almost always the case, especially in an inflation environment.

So if you are a global macro investor that is using the yield curve you can forecast when to get in and when to get out of stocks and bonds based on the macro economy. At the same time you can use the information and trade currency differentials as well.

Of course as with all things in the market nothing works every time. In fact the quote history never repeats itself, but it often rhymes is a very appropriate statement. Used along with proper risk controls the yield curve can become one of the global macro investors best timing tools and economic gauges.