Yield Curve Study

The yield curve is simply a ratio that is derived by dividing a long term yield with a short term yield.

For example, the yield for the US Treasury 3 month bill closed at 1.62 and the yield for the US Treasury 30 year bond closed at 4.66 on Tuesday. Therefore the value for the yield curve is 2.88 (4.66 divide by 1.62).

The steepness of the yield curve can be used to predict the performance of the stock market. This is because when the yield curve is steep, banks earn money by borrowing short term and to loan long term. The reverse happens when the yield curve is inverted or flat. Hence when the yield curve is steep, banks have every incentive to loan out as much as possible and to borrow to the limit of their reserves. And when that happens, there will be excess liquidity to drive up the stock market.

I have done a study by using the data from Yahoo (Symbol: ^TYX - 30 year bond and ^IRX - 13 week Treasury bill).


The trading rule is simple.

Enter
1. Compute the Ratio = (^TYX)/(^IRX)
2. If Ratio crosses value of 1.15, enter a long position

Exit
1. Closed the long position after 12 months.

The trading result is as follows:

Entry Date	Entry Price	Exit Date	Exit Price	% Change	Draw Down %	Max Gain %	Bars Held
6/2/1980	850.85	6/1/1981	991.75	16.56	-1.1929	21.1706	12
12/1/1981	888.98	12/1/1982	1039.28	16.91	-13.3861	21.3143	12
6/1/1982	819.54	6/1/1983	1199.98	46.42	-6.0473	51.8523	12
8/2/1982	808.60	8/1/1983	1199.22	48.31	-4.7762	55.9139	12
5/1/1990	2656.76	5/1/1991	2887.87	8.7	-11.7606	14.0656	12
9/4/1990	2614.36	9/3/1991	3043.60	16.42	-10.3295	17.3767	12
2/2/1998	7987.46	2/1/1999	9405.43	17.75	-7.6089	22.1845	12
4/1/1998	8818.50	4/1/1999	9825.29	11.42	-16.3157	15.1961	12
8/3/1998	8868.10	8/2/1999	10654.83	20.15	-16.7837	27.6667	12
10/1/1998	7749.42	10/1/1999	10335.69	33.37	-4.5118	47.4812	12
1/4/1999	9212.84	1/3/2000	11501.85	24.85	-2.3726	26.5482	12
4/2/2001	9877.16	4/1/2002	10402.07	5.31	-19.7448	15.7865	12
9/4/2007	13358.39	Open	Open	-2.91	-13.8464	6.8988	9