Understanding Flattening Yield Curves

Medium Term Structure Dynamics Yield Curve Construction

Market participants often analyze the shape and movements of the yield curve to gather insights on future interest rate expectations and economic conditions. The yield curve is constructed using various maturities of interest rates, typically derived from government securities such as Treasury bonds.

Suppose a financial analyst observes that the current yield curve is upward sloping, indicating that long-term rates are higher than short-term rates. The analyst is tasked with explaining the factors that can contribute to changes in the yield curve and the implications of various yield curve shapes.

Which of the following statements correctly describes a potential consequence of a flattening yield curve?

A flattening yield curve typically indicates that investors expect slower economic growth and lower inflation.

A flattening yield curve is primarily caused by increasing demand for long-term government bonds.

A flattening yield curve suggests that the central bank is likely to raise short-term interest rates in the near future.

Hint

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