Rolling Down the Curve – A Strategy for a Steep Yield Curve
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Currently, the Treasury yield curve is exceptionally steep and normal shaped (i.e., shape of the yield
curve when short rates are lower than long rates), while short-term and money-market funds are
simultaneously yielding historic lows near zero percent. When the yield curve is steep it means that
market participants expect rates to be higher in the future than they are today. The combination of
these factors creates a yield curve which provides investors with an opportunity to “roll down the
curve”. As a bond approaches maturity it will gradually “roll down the curve” toward lower yields each
year as it moves closer to maturity. As this occurs the bond will be valued at successively lower yields
and thus potentially higher prices as it gradually moves down the yield curve. This strategy may help
protect principal in a rising interest rate environment and allow an investor to capture higher yields. This
strategy works best when the yield curve remains upward sloping and when rates rise less than the
markets are predicting. Conversely, if yields rise by the full amount that the markets predict, the
benefits of this strategy could be zero.
Current Short to Intermediate Rates Provide an Excellent Backdrop
The chart below illustrates how the 2yr-5yr spread has risen dramatically over the last few months to as
much as 140bp, more than double what it was in early 2013 and its highest level since 2011. Today’s
environment provides a unique opportunity to provide roll returns in shorter-term maturities that were
once reserved almost exclusively to their longer- dated counterparts. Given that the difference (spread)
between the 2-year and 5-year Treasuries has been increasing (steepening), this provides an excellent
opportunity to “roll down the curve.” Positioning in the 2-5yr maturity range instead of the 5-10yr
portion can also help limit interest rate risk, or the risk of a decline in bond prices due to the rise of
interest rates.
Treasury Curve Slope: 2-5 Year Maturities Offer the Best Roll Return
(Data as of 1/13/2014)
The chart below examines the opportunity in the 2-year to 10-year maturities for this strategy as
indicated by a 6-month roll-down return. The bars on the right-hand scale indicate the roll-return for a
given maturity over a 6-month holding period assuming that the yield-curve remains the same. Under
this scenario, a 5-year Treasury held for 6-months would appreciate in price by nearly 83bp as the bond
“rolls down the curve” towards a lower portion of the yield-curve. In essence, a bond will appreciate in
value as yields decline due to the passage of time, thereby providing a cushion in the form of a higher
total return. In the current environment, 5- and 7-year maturities (indicated in green) can provide better
roll return while also limiting duration and interest rate risk.
Roll-down Return for the Treasury Curve: A 6-Month Example
(Data as of 1/13/2014)
Similar to the Treasury yield curve, typical corporate yield curves remain normal in shape and provide a
similar roll-down opportunity to that of Treasuries. Notice that the 7-year maturity provides a premium
to that of the preceding 5-year maturity and a similar pattern is evident from the 5-year maturity as it
rolls toward a 4-year. This trend is also apparent in the 8-year or longer space but the effects are muted
as the time to maturity lengthens.
Bloomberg ‘BBB’ Corporate Index Spread to Treasuries
(Data as of 1/13/2014)
How to Implement this Strategy
When selecting bonds to utilize a “rolling down the curve” strategy attempt to locate bonds in the
steepest areas of the yield curve. Currently, the Treasury yield curve provides opportunities in both
short and intermediate maturities with the short-end providing a unique opportunity to implement this
strategy. As indicated by the Bloomberg corporate ‘BBB’ Index in the chart above, corporate bonds
provide a more broad set of maturity opportunities but correspond to Treasuries as the 5- to 7-year
sections of the yield curve provide strong roll-down potential. There are risks involved with this strategy
including, but not limited to, changes in interest rates, liquidity, credit quality, volatility and duration.
Past performance is no assurance of future results. Investors should discuss the risks inherent in bonds
with their Raymond James Financial Advisor.
This piece was prepared by Fixed Income Services of Raymond James
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst.
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Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates,
liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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