Bear Flattener

Bear flattener is a yield-rate environment in which short-term interest rates are increasing at a faster rate than long-term interest rates. This causes the yield curve to flatten as short-term and long-term rates start to converge.

The yield curve is a graph that plots the yields of similar-quality bonds against their maturities, ranging from shortest to longest. Typically used in reference to U.S. Treasury securities, the yield curve shows the yields of bonds with maturities ranging from 3 months to 30 years. In a normal interest rate environment, the curve slopes upward from left to right, indicating a normal yield curve. A normal yield curve is one in which bonds with short-term maturities have lower yields than bonds with long-term maturities. The short end of the yield curve based on short-term interest rates is determined by expectations for the Federal Reserve policy; it rises when the Fed is expected to raise rates and falls when interest rates are expected to be cut. The long end of the yield curve is influenced by factors such as the outlook on inflation, investor demand and supply, economic growth, institutional investors trading large blocks of fixed-income securities, etc.

The changes in the short-term or long-term interest rates leads to a steepening or flattening of the yield curve. The yield curve steepens when the difference between short- and long-term yields increases. This tends to occur when interest rates on long-term bonds are rising faster than rates on short-term bonds. If the curve is flattening, the spread between long-term rates and short-term rates is narrowing. A flattener can either be a bull flattener or a bear flattener.

A bull flattener is observed when long-term rates are decreasing at a rate faster than short-term rates. The change in the yield curve often precedes the Fed lowering short term interest rates, which is a bullish signal for both the economy and the stock market.

On the other hand, when short-term rates are rising more rapidly than long-term rates, the result is a bear flattener. When the yields on short-dated bonds rise more quickly than yields on long-term bonds, eventually, both interest rates start to converge. The convergence, in turn, flattens the yield curve when plotted on a graph. For example, on February 9, the yield on a 3-month T-bill was 1.55% and the yield on a 7-year note was 2.72%. The spread during this time was 2.72% - 1.55% = 117 basis points. On April 1, the 3-month bill yields 2.05%, while the 7-year note yields 2.80%. The spread is now smaller at 2.80% - 2.05% = 75 basis points, leading to a flatter yield curve.

As explained above, the increase in short-term rates is usually due to actions by the government through the Federal Reserve, which decides to increase rates to slow economy growth and/or the expected inflation growth. In other words, a flattening curve is typically an indication of a slowing economy and is not beneficial to banks as funding costs increase. Therefore, a bear flattener is considered a bearish indicator on the economy.

A bear flattener may be a signal to investors that the higher interest rates on short-term bonds may produce a higher return than stocks will in the short-term. In effect, increasing interest rates drives short-term bond prices down, increasing their yields rapidly in the short term, relative to long-term securities. In this case, investors will sell their stocks and invest the proceeds in the bond market, which will lead to a bearish stock market.