Executing Forward Treasury Curve Steepeners with Bonds or Swaps
Summary
A one-year-forward 2-year versus 5-year Treasury steepener can be built from bonds with settlement in one year or expressed through forward-starting interest rate swaps. For bonds, the examples construct forward exposures by combining securities that mature at different dates; the resulting positions are sized to offset DV01. Swaps can express the forward tenors directly, with fixed-rate exposures sized on a duration-equivalent basis.
The trade reflects a view that the future curve slope will be steeper than the slope implied by today’s forward curve. The document illustrates this with a spot spread wider than the one-year forward spread, and explains that a trader might enter if they expect the future spot spread to remain wider. Practical limits include the difficulty of arranging long-settlement Treasury trades and the financing cost of bond positions through overnight repo. Shorted securities that become scarce in repo may have especially high carry costs. The DV01 examples are explicitly simplified.
Key ideas
- A forward Treasury steepener can be constructed from bonds settling on a future date.
- Forward-starting swaps allow traders to express curve views directly.
- Bond positions should be sized to offset DV01 across the curve legs.
- The trade profits if the future spot curve steepens relative to the forward-implied slope.
- Long-settlement availability and repo financing costs can constrain bond implementation.
Tags
Full text
# How is 1y5y - 1y2y Treasury steepener trade executed? # How is 1y5y - 1y2y Treasury steepener trade executed? This is a 1-year forward, 2y - 5y steepener trade. How is this executed? Are actual Treasury bonds involved or are these just forward contracts between two parties? Is the trade expressing the fact that 2y - 5y curve is flat looking 1 year forward? How can one express a view on the curve 1 year forward, 2 year forward, 3 year forward, etc...It seems like the further you go out in forward space, the more uncertainty you have. ## Answer by dm63 (score 5) https://quant.stackexchange.com/a/39061 To do such a trade would require selling a 6 year Treasury , and buying a 3 year Treasury, both with a settlement date of one year from now. This is actually hard to do in practice, since not many dealers offer such long settlement dates for Treasury transactions. It is much easier to do this trade in interest rate swaps , where you can easily do a 1yr-5yr forward swap versus a 1yr-2yr forward swap. One would pay fixed on the former and receive fixed on the latter, in duration equivalent amounts. These trades are often done to take advantage of the fact that the yield curve implies that it will be flatter in the future. For example the slope (5yr-2yr) may be 25bp on a spot basis but only 10bp on a 1yr forward basis. Thus, you would do the trade if you believe the spot spread one year from now will still be 25bp. ## Answer by Attack68 (score 3) https://quant.stackexchange.com/a/39112 Suppose the following (incorrectly simplified) DV01s: 1Y 1mm = 100, 2Y 1mm = 200, 3Y 1mm = 300, 4Y 1mm = 400, 5Y 1mm = 500, 6Y 1mm = 600, To execute a short in 500 dv01 of a 1Y5Y you need to sell 1mm 6Y and buy 1mm 1Y. This gives you forward bond exposure. To execute a long in 500 dv01 of 1Y2Y you need to buy 2.5mm 3Y and sell 2.5mm 1Y. The combination of the above is: sell 1mm 6Y, buy 2.5mm 3Y and sell 1.5mm 1Y. You will observe the total DV01 = zero. If you executed the above in par swaps it would amount to the same forward risks, the only difference being in swaps you can also trade the forwards directly. The other point to note is that you would have to fund the positions in bonds with o/n repo. If you have sold some bonds that might go special on repo this might amount to a considerable cost-of-carry.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.