Yield Curve Implications From Widening Spreads

Very Hard Term Structure Dynamics Yield Curve Construction

A fixed income analyst is evaluating the current market conditions impacting the yield curve of corporate bonds compared to government bonds. The analyst observes that the spread between the yields of 10-year corporate bonds and 10-year government bonds has been widening over the past month. Additionally, the analyst notes that the central bank recently hinted at potential interest rate hikes due to rising inflation expectations.

Given this scenario, the analyst is curious about the potential implications for the shape of the yield curve. Which of the following statements best describes the likely outcome for the yield curve in light of the observed conditions?

The yield curve is likely to flatten as investors expect interest rates to rise.

The yield curve is likely to steepen due to widening spreads and expectations of future rate hikes.

The yield curve will remain unchanged as changes in corporate spreads do not affect government bond yields.

Hint

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