In this segment, Pete looks at the relationship between the spread on the 10 year notes to that a of the 2 year notes. This spread is commonly referred to as the TUT spread. It is especially important as it helps to give us an idea of the current shape of the yield curve. Pete goes on to explain that the yield curve is simply the plot of the varying maturities on bonds typically we see this done between 3 months and 3 years. Traders will keep an eye on the TUT spread as it will give an indication of where interest rates might be heading.
Pete continues with his presentation explaining how the shape of the yield gives investors a sense of economic expectations. So in general, strong economies mean there is a steepening of the yield curve. Meaning longer maturities yields increase more than shorter maturity yields. This is compared to weak economies which means there is a flattening of the yield curve, meaning longer maturity yields decrease more than shorter maturity yields.
Next Pete looks at possible curve trades that are flattener and steepener strategies. These consist of getting long or short near term front and back month bonds. An example of a curve flattening strategy would be selling the spread, this is short the front leg and long the back leg. An example of a steepener trade would be buying the spread, which is long the front leg and short the back leg.
The risk measure used for curve trades is the dollar-value of a basis point basically this can be thought of as the delta of a bond. The back leg will alway have a greater basis than the front leg, so a hedge ratio must be calculated to result in a basis neutral position. This is essentially creating a delta neutral position with options.
Pete ends the segment by looking ways the gold market can be traded by taking advantage of the information provided by the yield curve and the TUT spread.
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