We launched a so-called TUT What are trading spreads? In online trading, spread is the d... More this month to take advantage of the current low What are interest rates in trading? When one party lends mo... More differential in US Bonds are debt instruments, which means they are a way of ... More in conjunction with the emerging bear What are value stocks? A value company is a company that app... More.
What is a TUT spread?
The TUT spread is a spread in US bonds that uses 10-year and 2-year bonds. When you trade such a bond spread, you usually expect the yield curve to either flatten or become steeper. As we currently find a very flat yield curve, we are betting on a steeper curve. If you want to learn more about bonds, you can visit our course.
Current yield curve
The following simple chart shows you the individual What is interest? In finance and trading, interest is a fe... More rates that currently prevail for the different maturities on the market. If you look at the absolute interest rate differentials, you will see that they are very small.
What does the current interest rate difference look like?
The following chart shows the historical development of the interest differential between the 10-year and the 2-year US government bonds:
You can clearly see that the interest differential has fallen to almost zero. The past has shown that such a low interest rate differential is rare. Now one could argue that it already clearly went into the negative range and that this condition can last several months. That is correct. For this reason, filters are used to get cleaner signals. The How do stock markets work? A stock market is a financial ... More is one such filter.
Why does the stock market play a role in the TUT spread?
The following chart also shows the interest rate differential and the S&P 500 (red):
In the green areas, you can see an opposite movement of the interest rate differential to the stock market. If you take into account the initial level of the interest rate differential, you obtain a meaningful signal. In both major bear markets of the last 20 years, the interest rate differential was very small and began to grow when the stock market fell. In our estimation, we currently find this exact situation again.
Inverse movement of interest rates to bonds
We are banking on an expansion of the interest rate differential with our trade. The interest difference becomes larger again if one of the following scenarios occurs:
- 10-year US bond yields are rising faster than 2-year US bond yields
- 10-year US bond yields are weaker than the 2-year US bond yields
- 10-year US bond yields rise and yields on 2-year US bonds stagnate or fall
- 10-year US bond yields stagnate and yields on 2-year US bonds fall
Unfortunately, it is not possible to trade yields yourself. Fortunately, there is a sensible alternative: bond prices. There is a very high negative correlation between interest rates and bond prices. Put simply; interest rates are falling, bond prices are rising and vice versa.
The following chart shows the negative correlation at the bottom of the example for 2-year US bonds:
It is, therefore, possible for us to bet on a widening of the interest differential by trading the bonds with a TUT spread.
Our implementation of the TUT spread
We have implemented the trade as follows:
- Purchase of 2-year US bonds (March maturity)
- Sale of 10-year US bonds (March maturity)
We will be watching the evolution of this TUT spread very closely and realize that we will have it in our account for longer and may roll several times.