In anticipation of a Federal Reserve move, some investors are turning to an alternative fixed-income exchange traded note that capitalizes on a flattening yield curve.
The yield curve has flattened after a strong 30-year Treasury bond auction pushed up prices in long-term bonds and depressed yields, Reuters reports.
Meanwhile, on the shorter end of the Treasury bond market, yields on short-term maturities are hitting new six-year highs as traders trimmed securities in anticipation of a FOMC rate hike on Wednesday.
“The main theme has been a flatter curve with the front end trading very heavy to the highest yields in a few years and the long end just trying to hold in above the auction stop,” Justin Lederer, Treasury analyst at Cantor Fitzgerald, told Reuters.
On Wednesday, the iPath US Treasury Flattener ETN (NYSEArca: FLAT) rose 2.4%. FLAT is designed to capture returns available in the U.S. Treasury yield curve environment by “flattening” the U.S. Treasury yield curve.
Specifically, the iPath U.S. Treasury Flattener Exchange Traded Note reflects the daily inverse performance of the Barclays Capital U.S. Treasury 2Y/10Y Yield Curve Index, which implements a sophisticated investment strategy that allows investors to bet on slope of the yield curve.
The level of the index increases as the yield curve steepens and decreases as the yield curve flattens. FLAT employs a strategy that seeks to make money when the two-year versus 10-year yield spread declines, taking a bearish short position on the underlying.
Simply put, FLAT performs when the the spread between two-year and 10-year yields declines, or “flattens,” by going long two-year note and taking a short position in the 10-year note.
The Treasury yield curve is typically upward sloping because investors would usually demand more interest for locking up their money over long periods, creating a steep yield curve. However, this elevated state can not last in the long term, which may open an opportunity to buy the ETN.
For more information on the fixed-income market, visit our bond ETFs category.