Although the Federal Reserve (the Fed) has been on pause when it comes to interest rate hikes since the summer of 2023, economic uncertainty still looms. The Fed is reducing the size of its balance sheet by decreasing holdings of Treasury and mortgage backed securities, and it is ambiguous on when the first rate cuts will take place.
Given the uncertain economic environment, it is as important as ever to manage Treasury yield curve risk.
The United States Treasury market stands as one of the largest and most crucial financial markets globally, playing a pivotal role in the functioning of the global economy. The magnitude of the U.S. Treasury market reflects its significance as a safe haven for investors, central banks and institutions seeking low-risk assets. Treasury maturities across the yield serve as an important reference point for risk management across various markets.
The yield curve shape holds significance in the financial markets, serving as a valuable indicator of economic health and expectations. This graphical representation of interest rates on Treasury instruments with different maturities provides insights into the prevailing market sentiment and expectations for future economic conditions. Investors and policymakers closely monitor the yield curve for its predictive power regarding economic recessions and recoveries.
Exhibit 1 – CME Group BrokerTec U.S. Treasury Benchmark (3:00 p.m. fixing) (January 30, 2024)
Moreover, the yield curve guides investment decisions, helping investors assess risk, make strategic asset allocation choices and implement effective hedging strategies.
CME Group Yield futures
CME Group Yield futures are cash-settled instruments, with the final settlement value referencing the on-the-run (OTR) 2-, 5-, 10- and 30-year Treasury securities, as tracked by the BrokerTec U.S. Treasury Benchmark Indices. Each contract has a value of $1000 per index point, and the minimum price increment is set at 0.001 or 1/10th basis point. This structure permits a minimal price fluctuation of only $1.00 per contract. This means that each basis point of the Yield futures contract is worth $10, and the contract size of the product is $1,000 x the index points.
Yield futures are anchored to consistent maturity points by cash settling at month-end to the most recently issued Treasury security. This stands in contrast to traditional U.S. Treasury futures, which have successfully developed liquidity using a deliverable basket of securities with cheapest-to-deliver dynamics.
Yield futures were strategically designed to uphold a consistent risk exposure. Featuring a fixed $10 DV01 (dollar value per basis point of yield move), they effectively eliminate convexity, the nonlinear relationship between price and yield. The uniform DV01 across the entire curve facilitates straightforward Inter-Commodity Spread (ICS) calculations and hedging. It allows for the hedging of any pair of points on the curve by employing a 1:1 ratio with the two Yield futures in the opposite direction. The yield difference in basis points can be determined by subtracting the prices of the two contracts.
The simplified roll process is noteworthy, especially given the monthly auction schedule. Monthly Yield futures maintain a consistent 1:1 roll ratio, eliminating the need for complex calculations to match exposure during rolls, as required in traditional fixed-notional contracts with varying DV01 values between adjacent quarters.
Between the 2-, 5-, 10- and 30-year tenors, all possible ICS tenor-pairs are available for trading.
To learn more about Yield futures basics, visit Understanding Yield futures.
What is a yield curve spread?
Yield curve spreading involves analyzing and capitalizing on the disparities in yields between different maturities of U.S. Treasury instruments. By taking positions that leverage the spread between yields on various maturity points, market participants aim to profit from anticipated changes in interest rates. This strategy often involves simultaneously entering long and short positions on different segments of the yield curve.
Strategies involving yield curve spreading often revolve around predicting the curve's steepness or flatness. A large spread value indicates a steep yield curve, while a value near 0 signifies a flat curve. A negative spread value implies an inverted yield curve.
Suppose a trader anticipates a steepening yield curve. In such a scenario, the trader can initiate a spread position with a long front leg and a short back leg. This position would prove successful if the yields of the two maturities diverge, leading to an increased spread size.
Yield curve spreading is not only a means of potential profit but also a tool for risk management, allowing market participants to hedge against interest rate fluctuations and optimize their overall portfolio performance.
2-Year Yield futures/10-Year Yield futures (2YY/10Y) Spreads
The 2YY/10Y Treasury Yield futures spread demonstrates the difference between the 10-year Treasury yield and the 2-year Treasury yield. It is one of the most commonly referred to indicators of yield curve steepness.
Exhibit 2- 2 Year Yield futures vs. 10 Year Yield futures (December 29, 2023 to January 18, 2024)
Exhibit 3 – 2Y-10Y Yield futures Spreads (January 2, 2024 to January 20, 2024)
On January 2, 2024, the yield of the 2-Year Yield futures contract was 4.228, and the yield of the 10-Year Yield futures contract was 3.939, as seen on Exhibit 2. The yield of the 2 year is greater than the yield of the 10 year, indicating an inverted yield curve. Suppose that a trader believes that the curve will begin to flatten out, meaning that the spread between the 2-year yields and 10-year yields will narrow.
The trader can then enter in the following spread position:
Short position of ten 2YY contracts @ 4.228
Long position of ten 10Y contracts @ 3.939
Subtracting the two values means that the spread between the yields is -0.289 basis points.
Two weeks later on January 16, 2024, the 2-Year Yield futures contract dropped to 4.160, and the 10-Year Yield futures contract yield rose to 4.066. The spread between the yields narrowed to -0.094 basis points, confirming the trader's hypothesis. The movement of the yield curve can be seen in Exhibit 4 below. Although the curve is still inverse, it flattened out to be less negative.
Exhibit 4 – 2Y-10Y Yield curve (January 2, 2024 and January 16, 2024)
Exhibit 5 – 2Y-10Y Yield futures spreads (January 2, 2024 to January 20, 2024)
January 2, 2024
January 20, 2024
Source: CME Group Treasury Analytics
As can be seen in Exhibit 3 and 5, the spread has narrowed 19.5 basis points (-0.289 minus -0.094). Since the DV01 of Yield futures is a constant $10, we know that the position has increased by $195.00 (19.5 basis points x $10 DV01) per contract. Given that the trader entered in 10 contracts, the overall value of his position has increased by $1950.00 ($195.00 per contract x 10 contracts).
To visualize movements in Yield futures prices over time and compare those with both the BrokerTec U.S. Treasury Benchmark cash yields and constant maturity rates (par rates) published by the U.S. Department of the Treasury, visit the Treasury Analytics CurveWatch tool from CME Group.
Exhibit 6 below shows the 2-Year - 10-Year Yield futures spread over a one year period.
Exhibit 6 – 2Y-10Y Yield futures spreads (January 24, 2023 to January 24, 2024)
With the utilization of Yield futures spreads, specific interest rate risks can now be more effectively managed through yield curve movements. With a more compact contract design, combined with the uniform DV01, Yield futures strengthens the already dynamic Treasury futures complex at CME Group.
Exhibit 7– Contract specifications for CME Group Yield futures
$1,000 x Index points ($10 DV01)
Percentage points of yield per annum
TRADING and Clearing HOURS
Sunday - Friday 6:00 - 5:00 p.m. ET (5:00 - 4:00 p.m. CT).
Monday - Thursday 5:00 - 6:00 p.m. ET (4:00 - 5:00 p.m. CT) daily maintenance period
Sunday 6:00 p.m. ET (5:00 p.m. CT) - Friday 6:45 p.m. ET (5:45 p.m. CT) with no reporting
Monday - Thursday from 6:45 - 7:00 p.m. ET (5:45 - 6:00 p.m. CT)
MINIMUM PRICE FLUCTUATION
0.001 Index points (1/10th basis point per annum) = $1.00
Calendar spreads: 0.001 Index points
CME Globex: 2YY, 5YY, 10Y, 30Y
CME Globex Matching Algorithm
F - FIFO
Monthly contracts listed for 2 consecutive months
TERMINATION OF TRADING
Trading terminates on the last business day of the contract month.
BLOCK TRADE MINIMUM THRESHOLD
RTH – 2,000 contracts
ETH – 1,000 contracts
ATH – 500 contracts
BLOCK TRADE REPORTING WINDOW
RTH – 5 minutes
Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is
possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade.
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The information within this communication has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. CME Group does not represent that any material or information contained in this communication is appropriate for use or permitted in any jurisdiction or country where such use or distribution would be contrary to any applicable law or regulation.
Additionally, all examples in this communication are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and superseded by official CME, CBOT, NYMEX and COMEX rules. Current rules should be consulted in all cases concerning contract specifications.
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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.