Schweser says: During high rate of inflation, long-term interest rates is higher and, therefore, upward-sloping yield curves will occur. vice versa for decreasing inflation rate. I’m kinda stuck on why long-term interest rates is higher during/expected inflation time. Can someone help?
I guess it woud be easier to understand if u use your economics material. when inflation is high, the Government increases interest rates to control inflation. Hope im right!!
Rates increase so the real reaturn remains positive. If you expect future inflation to be higher than current inflation, a 5 year bond will need to have a higher return than a 1 year bond.
That’s the key Freakshow, “future inflation”. I don’t fully agree with that Schweser quote and yield curves can be really strange sometimes. The fact that ‘today’ we have a high rate of inflation says nothing about future expectations. It also depends a LOT in the currency you’re dealing with, so I’d be very careful about any generic statement regarding yield curves.
Hmm… I don’t think it depends on currency. The yield curve for any currency should reflect inflation expectations in that currency. What’s the issue?
different country different inflation rate?
yes, that was what i mean with different currencies. different countries, different currencies, different inflation/IR rates, different yield curve aspects
Fine with that. And of course, the thing that links the two yield curves is the forward exchange rate curve.