what do these yield curves tell us about the public s expectations of future movemen 638236

Interpreting Yield Curves, 1980–2010

Figure 5.7 illustrates several yield curves that have appeared for U.S. government bonds in recent years. What do these yield curves tell us about the public’s expectations of future movements of short term interest rates? The steep inverted yield curve that occurred on January 15, 1981, indicated that short term interest rates were expected to decline sharply in the future. For longer term interest rates with their positive liquidity premium to be well below the short term interest rate, short term interest rates must be expected to decline so sharply that their average is far below the current short term rate. Indeed, the public’s expectations of sharply lower short term interest rates evident in the yield curve were realized soon after January 15; by March, three month Treasury bill rates had declined from the 16% level to 13%. The steep upward sloping yield curve on March 28, 1985, and May 13, 2010, indicated that short term interest rates would climb in the future. The long term interest rate is higher than the short term interest rate when short term interest rates are expected to rise because their average plus the liquidity premium will be higher than the current short term rate. The moderately upward sloping yield curves on May 16, 1980, and March 3, 1997, indicated that short term interest rates were expected neither to rise nor to fall in the near future. In this case, their average remains the same as the current short term rate, and the positive liquidity premium for longer term bonds explains the moderate upward slope of the yield curve.