Changes in short term rates - impact on LT yield curve


The book says that usually an increase in ST rates leads to higher mid and LT yields. However, that they may actually fall, if interest rates increase is gauged sufficient to slow the economy.

Can someone explain this relationship. Also, why would rates generally rise in the mid and LT? It makes more sense for me that they fall given expectation of lower economic activity and lower inflation.

If you believe the liquidity preference theory for explaining the shape of the yield curve, than an increase in short-term yields is likely to result in an increase in mid-term and long-term yields as investors in each would demand a liquidity premium over the (new, higher) short-term rate.

Ok. It’d make sense with that assumption taken.

So, once again, it depends on whichever force is stronger, correct?


There’s a reason that there are several theories for the shape of the yield curve: none of them does a good job explaining it all of the time.

Yes: lots of forces. Sometimes the bulls win, sometimes the bears win.

The hogs, alas, always get slaughtered.