Understanding Implications of an Inverted Yield Curve

Medium Term Structure Dynamics Yield Curve Construction

Consider a scenario where the yield curve has completely inverted, with short-term interest rates exceeding long-term rates. This situation is typically viewed as a potential precursor to an economic downturn. In this context, which of the following statements correctly describes a potential implication of an inverted yield curve when constructing the yield curve?

An inverted yield curve signals strong investor confidence, leading to increased investment in long-term debt securities.

An inverted yield curve suggests that investors expect short-term interest rates to decrease in the future, indicating a potential reduction in economic activity.

An inverted yield curve is primarily caused by central banks raising short-term interest rates in response to anticipated inflation.

Hint

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