Flat Yield Curve - Explained
What is a Flat Yield Curve?
Written by J. Mance Gordon
Updated at April 22nd, 2024
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What is a Flat Yield Curve?
The flat yield curve is a yield curve that depicts the difference between two bonds (short-term and long-term debt securities) that belong to the same category of credit. The flat yield takes the form of a horizontal line which shows that a short-term bond and long-term bond with the same credit quality have a little discrepancy in terms of yield. When there is a change from a normal yield curve to an inverted yield curve, the flat yield curve emanates.
How Does a Flat Yield Curve Work?
The flat yield curve occurs when a short-term bond and a long-term bond with the same credit quality offer diverging yields. If a yield curve flattens, it shows that the long-term bond experiences a spread in terms of yield while the short-term bond is decreasing in terms of yield. In the investment market, when there is no different in the yields that investors can benefit from short and long-term bonds, they prefer holding short-term bonds.
Reasons for a Flattening Yield Curve
A flat yield curve occurs due to a number of reasons. If there is a flattening of the yield curve, it could be as a result of a tendency of decrease in inflation. Also, an increase in the rate of federal funds which are kept in federal reserve as another reason that cause a flattening yield curve. Another cause of flat yield curve is an increase in the rates of short-term bonds which is above long-term rates.
Barbell Strategy for Flattening Yield Curve
The Barbell strategy is a strategy used when investors trade in both long and short-term bonds, especially when there is an increase in interest rate or there is a rise in the value of short-term securities. In the case of a flat yield curve, when there is a tendency that the Federal Reserve would increase the federal funds rate, investors can be at the advantageous side using the barbell strategy. This means, investors can have investment portfolio made up of long-term bonds and short-term bonds. This would mean that the investors can be sure to benefit from the changes that can occur in the market.