In 2012, an article in the Wall Street Journal contained the following observati

Question

In 2012, an article in the Wall Street Journal contained the following observation: "The fact that Spanish short-term yields are shooting higher than long-term yields is a particularly bad sign." Why might this development in the market for Spanish government bonds indicate that investors feared that the Spanish economy would enter a recession? Source: Matt Phillips, "Flatliners: Spanish Yield Curve Flattening Hard!" Wall Street Journal, July 23, 2012. If yields on long-term bonds are lower than yields on short-term bonds then the yield curve is: inverted . An inverted yield curve may be a predictor of a future recession since it is a sign that the financial market believes that the Federal Reserve will be conducting stimulative monetary policy in the future which will _______ interest rates, and short-term rates tend to fall _______ than long-term rates. A. increase: less B. increase: more C. decrease: more D. decrease: less

Explanation / Answer

c. decrease:more

An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession. When short-term interest rates exceed long-term rates, market sentiment suggests that the long-term outlook is poor and that the yields offered by long-term fixed income will continue to fall. The curve is ascending, with more-volatile long-term bonds having higher yields than short-term obligations. But occasionally the curve inverts, with long-term bonds yielding less than treasury bills. An inversion of the yield curve, when short-term interest rates are higher than long-term rates has been considered as a reliable predictor of recessions.

If yields on long-term bonds are lower than yields on short-term bonds then the yield curve is

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