Which strategy should be used when the yield curve is expected to steepen?

When the yield curve is expected to steepen, employing a bullet strategy is particularly effective because it allows an investor to concentrate their bond investments in a specific maturity that is expected to benefit the most from rising interest rates.

In a steepening yield curve scenario, long-term bonds typically increase in yield relative to short-term bonds, meaning that the prices of long-term bonds will tend to drop less than those of short-term bonds in a rising rate environment. By using a bullet strategy, an investor can target the maturity that is anticipated to provide the best risk-return profile based on expected market movements. This positions the portfolio to maximize gains from the steeper yields at that maturity, while also limiting exposure to the potential price declines of long-term bonds across the entire curve.

In contrast, a barbell strategy, which involves investing in both short and long-term bonds, may not capture the full benefit of a steepening yield curve in a specific segment of the maturity spectrum. Similarly, a ladder strategy, which equally spreads investments across a range of maturities, can dilute the potential benefits of focusing on a single point of the curve where steepness is expected, and holding a portfolio of short-term bonds may underutilize the opportunity provided by the anticipated movement at longer