Rashika BhatiaAdvanced
What is steeper for short term and flattening for long term? Explanation required for the whole question as well.
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Early expansion phase is characterized by rising short term rates and bottoming out long term rates. This means that short term end of the yield curve is steepening and the long term end of the yield curve has already started flattening and is soon going to start getting steep as this phase ends.
So, the write up regarding the gradient of the short and long term rates is consistent with early expansion.
Secondly, early expansion is the phase when the stimulative policies of the previous recession phase start becoming less stimulative. Note that in this phase the policies don’t start becoming restrictive! They start becoming less stimulative. The subtle difference between the two is important. Gradually as the cycle moves to the late expansion stage, restrictive policies come to existence.
So, in this question ….we are in early expansion phase of the business cycle in which economy is recovering fast and markets expect that central banks will hike rates in short term so short term rate is expected to increase ….now but when they will hike rates ..long term rates won’t go up as much as short term rates as longer term bonds will be of the view that current high recovery phase will slowdown once central banks start raising interest rates…so curve on the whole will become flatter and it will be more prominent in the long end part for example 10s30s part of the curve.
Current situation in the US, UK is very similar ..we are witnessing high inflation with low growth expectations so yield curve is becoming flatter and flatter with short term rates rising rapidly (2s) and long term rates staying flat or rising by less than short term rates (10s & 30s).
but US is not in an early expansion phase right now…