Carry Trade: Inter-market Trade

The paragraph below is from Textbook about Inter-market trade :

In order to eliminate currency exposure in an inter-market trade, the investor must, explicitly or implicitly, both borrow and lend in each currency. The essence of this trade is to exploit differences in the slopes of the two yield curves rather than the difference in overall rate levels. The idea, assuming normal, upward sloping yield curves, is to lend at the long end and borrow at the short end on the relatively steep curve, and to lend at the short end and borrow at the long end on the relatively flat curve. Among the ways to implement this trade are the following:

Receive fixed/pay floating in the steeper market and pay fixed/receive floating in the flatter market.

Take a long position in bond (or note) futures in the steeper market and a short futures position in the flatter market.

My question: why yield curve, not rate, is the essence of this trade? Why not receive floating and pay fixed (receive high pay low) in steeper market?

I am really struggling with this knowledge point. Please help. Thank you!

The essence of this sentence “Receive fixed/pay floating in the steeper market and pay fixed/receive floating in the flatter market” as outlined in the text is that the manager wants to be duration neutral and currency neutral.

This trade you describe is a loser. You would be paying a high rate and receiving a low rate. The float is the 6 month rate… And it also isn’t duration neutral so you have interest rate risk.

Thank you for reply.

If the float is 6 month rate, what rate is fix?

anything steeper than 6 months.

Can someone just clarify why one should take a long position in the futures in the steeper market (bunds) and a short position in the futures in the flatter market (Treasuries)? I may be too tired for this, but couldnt grasp it :slight_smile:

Long futures is similar to carry trade. Buy at the long term rate and pay the 6month or risk free rate.

Ah, of course! Pay the lower risk free and receive the higher is exactly what you do in this case. Thanks!