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Some off the top of my head

  1. 2s10s cash steepener, however this ages into a 1s9s over time
  2. 2s10s swap steepener, better/cleaner way?

Are there other ways to express this curve strategy? Would you do 6-month forwards 2s10s steepener?

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A 2s10s cash steepener is an abitrary position: long a 2Y bond and short a 10Y bond.

You have the following concerns:

a) Are your bonds really 2Y and 10Y or are they the closest points on the curve to those dates. Does it really matter in relation to the specificity of your view?

b) What about funding costs and the risk of specials for the short position in the 10Y? How are you funding the bonds, fixed term repo, or O/N general collateral? What are the associated carry costs with each.

c) Does buying multiple bonds and averaging the duration offer insurance against the funding risk (yes since you are diversifying) but dilute the specificity of the view (yes since you are diversifying)? Does buying multiple bonds and averaging the duration allow for a better constant maturity trade? Yes - becuase after a small period of time you roll the (relative small proportion) of the shortest bonds in each category and convert them to the longest bonds in each category, thereby extending duration after it has declined.

d) In liquid Government Bond (GB) markets you might have futures available e.g. schatz, bobl, bund, bobl in Germany or in US Treasuries.

e) Can you use interest rate swaps (IRS)? Yes but IRS are the usual leveraged derivatives for expressing generalised curve views. You typically express a 2s10s steepener in bonds because you have a specific view about the nature of those bonds (e.g. ECB 2017 announced decision to extend QE and allow short dated bond purchases below -0.4% YTM). Using swaps as a proxy will, in general, preclude the specific reason you are doing the trade.

f) If you use IRS the first floating period is fixed, which means your 2Y/10Y effectively becomes a 1.5Y/9.5Y 0.5Y fwd. This is a common source of unexplained PnL in position running since the traders do not recognise that their position then has an outright delta overlay which may mask the genuine relative movements of the 2Y/10Y sections. Whenever establishing a swaps positions I have used forward starting and have specifically chosen my notionals to give the precise volatility adjusted delta that I want.

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  • $\begingroup$ Agreed, this is a good summary of the choice of implementation, which is determined by a risk analysis which describes your desired, main driver. $\endgroup$ – rrg May 24 '18 at 11:16
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  • You appear concerned by roll. The solution is through a Constant Maturity Swap (CMS) strategy. I can implement a 2s10s steepener with (a) RCV a ten year CMS referenced to 2y rate, and (b) PAY a ten year CMS referenced to 10y rate. The life of this risk is ten years.

  • A spot or forward rate steepener strategy is (very slightly) harder to monitor, in that you would need to build or bootstrap your own curve. The 6m fwd 2s10s steeper proposition would add funding component to the analysis (by removing the problem of funding, for six months).

  • Roll-down implications are present in (1) and (2) of your qn: i.e. there is no difference here between IRS or bond steepener.

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