Bear Steepener

What Is a Bear Steepener?

A bear steepener is the widening of the yield curve caused by long-term interest rates increasing at a faster rate than short-term rates. A bear steepener is usually suggestive of rising inflationary expectations–or a widespread rise in prices throughout the economy. The rise in inflation can lead to the Federal Reserve increasing interest rates to slow prices from rising too rapidly. Investors, in turn, sell their existing fixed-rate long-term bonds since those yields will be less attractive in a rising-rate environment. The result is a bear steepener because investors sell long-term bonds in favor of shorter maturities as they wait for the rate hikes to finish before buying long-term bonds again.

Understanding Bear Steepener

A bear steepener occurs when there's a larger spread or difference between short-term bond rates and long-term bond rates–as long as it's due to long-term rates rising faster than short-term rates. U.S. Treasuries are typically used by investors to gauge whether interest rates are rising or falling. U.S. Treasuries are bonds–or debt instruments–issued by the U.S. Treasury to raise money for the U.S. government. Each bond typically pays a rate of return–or yield.

The difference between the short-term and long-term rates of various bonds and their maturities is plotted out graphically in what's known as the yield curve. The short end of the yield curve is based on short-term interest rates, which are determined by the market's expectations of Federal Reserve policy. Essentially, it rises when the Fed is expected to raise interest rates and falls when interest rates are expected to be cut. The long end of the yield curve is influenced by factors such as the outlook on inflation, investor demand and supply, economic growth, and institutional investors trading large blocks of fixed-income securities.

The Yield Curve and a Bear Steepener

The yield curve shows the yields of bonds with maturities ranging from 3 months to 30 years, whereby U.S. Treasury securities are typically used in the calculation. In a normal interest rate environment, the curve slopes upward from left to right, indicating a normal yield curve. A normal yield curve is one in which bonds with short-term maturities have lower yields than bonds with long-term maturities.

When the shape of the curve flattens, it means that the spread between long-term rates and short-term rates is narrowing. A flattening yield curve tends to occur when short-term interest rates are rising faster than long-term yields, or to put another way, when long-term rates are decreasing faster than short-term interest rates.

On the other hand, the yield curve steepens when the spread between short- and long-term yields widens. If the yield curve is steepening due to long-term rates rising faster than short-term rates, it's called a bear steepener. The term got its name because it tends to be bearish for equity markets since rising long-term rates indicate inflation and future interest rate hikes by the Fed. When the Fed hikes rates, the economy slows down, in part, due to higher loan and borrowing rates. The result can lead to investor selling of equities.

Special Considerations

Remember that there is an inverse relationship between bond prices and yield, that is, when prices go down, bond yields go up, and vice versa. A bond trader can take advantage of a widening spread brought about by a bear steepener by going long short-term bonds and shorting long-term bonds, creating a net short position. As yields increase and the spread widens, the trader would earn more on the short-term bonds purchased than would be lost on the shorted long-term bonds.

Bear Steepener vs. Bull Steepener

A steepening yield curve can either be a bull steepener or a bear steepener. A bull steepener is characterized by short-term rates falling faster than long-term rates. The two terms are similar and describe a steepening yield curve except that a bear steepener is driven by changes in long-term rates. Conversely, a bull steepener is driven by falling short-term rates having a greater impact on the yield curve. A bull steepener got its name because it tends to be bullish for equity markets and the economy since it indicates the Fed is cutting interest rates to boost borrowing and stimulate the economy.

Example of a Bear Steepener

Let’s look at an example in detail. On November 20, 2019, the yield for the 10-year Treasury note was 1.73%, and the 2-year Treasury note yielded 1.56%. The spread between both yields at that time was 17 basis points (or 1.73% - 1.56%)–which could be described as being relatively flat.

Let's say two months later, the bond yields for both securities rose whereby the 10-year was 2.73%, and the 2-year was 1.86%. The yield spread has now widened to 87 basis points (or 2.73% - 1.86%).

However, the difference between long-term yields is 100 basis points (2.73% - 1.73%), while the difference between short-term yields is 30 basis points (1.86% - 1.56%). In other words, the event is a bear steepener since long-term rates rose by a greater amount than short term rates over the same period.