We are now in a firmly hiking environment, unless something derails the US economy in the coming months. The US treasury curve has been flattening, with 2y:10y reaching new lows.
That being said, with 2-Year (and front-end) at historical highs, what happens if the Fed were forced to stop or even lower rates, due to some unforeseen shock events?
We generate plots of the yield curve behaviour from the past 2 yrs for some simple technical insights.
We plot the fitted curve, of the 2yr yield (which is the most sensitive bond to the continuous hiking cycle) to the various curve spreads (namely, the 2y:10y, 5y:10y, and 5y:30y).
Versus the 2yr bond yield, the 2y10y has a 'convexity' of 0.299; the 5y:10y has a 'convexity' of 0.135 and the 5y:30y has a 'convexity' of 0.173.
In trading terms, if we enter into hedged trades of 2yr yields versus curve spreads, we have the best possibility of making risk-adjusted returns by trading against the 2y10y.
Plainly speaking : If the 2yr were to tumble, the 2y:10y should increase more relative to the other curve spreads and if the 2yr were to increase further, the 2yr:10y similarly should flatten less than the other spreads.
Plan accordingly, against the possibility of shocks which causes the 2y to tumble.
