Consider the following scenario where an analyst is evaluating the yield curve based on recent economic indicators. The yield curve is showing an inverted shape, indicating that short-term interest rates are higher than long-term rates. The analyst has gathered the following information: The current short-term interest rate (1-year) is 4%. The current long-term interest rate (10-year) is 3%. The inflation rate is predicted to decrease over the next few years. The Federal Reserve is expected to lower its benchmark interest rate due to economic slowdown. Given these circumstances, which of the following factors is most likely contributing to the yield curve's shape?

Exam

CFA Level 2

Section

Difficulty

Fixed Income

Understanding Inverted Yield Curves

Very Hard Term Structure Dynamics Yield Curve Construction

Consider the following scenario where an analyst is evaluating the yield curve based on recent economic indicators. The yield curve is showing an inverted shape, indicating that short-term interest rates are higher than long-term rates. The analyst has gathered the following information:

The current short-term interest rate (1-year) is 4%.
The current long-term interest rate (10-year) is 3%.
The inflation rate is predicted to decrease over the next few years.
The Federal Reserve is expected to lower its benchmark interest rate due to economic slowdown.

Given these circumstances, which of the following factors is most likely contributing to the yield curve's shape?

Investors expect lower future short-term interest rates.

There is an increased risk premium associated with long-term bonds.

Market participants predict high inflation in the long run.

Hint

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