Why do we keep the duration neutral if just steepening is expected (not bear,bull)? Also if the duration is neutral, how does the portfolio earn a profit if the interest rate sensitivity (duration) is neutralized?
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Dont forget, we have for bonds:
delta px = duration x delta spread
So the longer your duration, the more leveraged you are in a way, the bigger your risk…
So if a pair is dv01 neutral (duration neutral), you’re also risk neutral, ie if the curve moves parallel up or down, you’re going to have no pnl.
Now, curves tend to naturally flatten when risk is cheaper / beta is up, because there is a lower term premia. So depending how you’re positioned (ie if you;re long or short the longest duration bond, and vice versa for the shorter duration bond, dv01 neutral), then you will gain/lose on risk-on/beta up, ie curve flattening.
Put differently, when you’re duration neutral, you only gain/lose if the curve flattens/steepens, whereas if you’re long/short duration, you have extra beta exposure on top.