Overview
One of the strategies to trade fixed income products is to base trades on a forecast of where interest rates are headed.
Forecasting Rates
- Term Structure Expectations: the term structure expectations hypothesis asserts that the market encodes its beliefs about the future level of interest rates (in particular, the short rate) into the level of longer term rates in the current term structure.
- IS-LM: the IS-LM model is the standard macro economic model based on Keynesian theory that explains short term production and income fluctuations. It explains the relationships between rates, money supply and national production.
- Technical Analysis: applies the tools of technical analysis to interpret the prices charts of fixed income instruments, or the trends and patterns in interest rate charts.
Trade Types
- Long (Carry): buying any fixed income instrument. This benefits when interest rates are flat or goes down.
- Short: shorting any fixed income instrument. This benefits when interest rates go up.
- Steepener: buying a instrument on the short end of the curve and shorting an instrument on the long end. This trade benefits when the curve steepens, that is, when the spread between the long and short rates goes up.
- Flattener: the flattener trade is the opposite of the steepener. It makes a bet that the curve will flatten.
- Butterfly: a butterfly occurs when the short end and the long end of the curve move more than the middle of the curve. That is the trader will go long on the long and short ends of the curve and short the middle, or go short the long and shorts and long the middle.
- Condor: