trying to get my head around these concepts,
- Fixed income reading says to me IR up and reduce the duration…i interpret this to mean when the yield curve steepens equivalent to IR increasing then reduce duration.
then when i go to reading 15 on the business cycle it says
- When yield spread is expected to widen, it is preferred to invest in longer-duration bonds; and defines yield spread as Positive or widening yield spread between long-term and short-term interest rates (i.e. a steepening or upward sloping yield curve)
this just seems like a contradiction
Taking a stab:
Rates going up doesn’t necessarily mean the yield curve has to steepen. If short-term rates are going up much faster than the long-end, it will be like a flattener. I would think of rates going up as a parallel shift here as opposed to a tilt in the curve shape.
I’ll try as well:
Not sure if we’re referring to the same example but I read that as yield spreads are expected to narrow, long duration bonds are expected to outperform short duration bonds.
I believe it is correct that as you expect interest rates to rise, then reducing your duration would be beneficial as it reduces the negative price impact to your portfolio.
What the reading 15 example is stating is that when an economic downturn is expected in the near future, there is more stability for an investor to invest in longer term bonds. Then you think about supply and demand - as demand for the longer term bonds are driven up due to investor expectations of the short term downturn, the longer term bond prices trickle upwards. Additionally, as recessions take place, the general move is for interest rates to lower in order to stimulate economic activity - and thus the longer term bond prices will trend upwards based on the inverse relationship between bond prices . As a result, you have less yield for the longer term bonds but better performance as indicated by future growth and economic bounce back when compared to the shorter duration bonds.
I think you’re getting confused with rates moving in parallel vs curve spread vs credit spread.