Question

19.On May 1 L 2020, Federal Reserve Bank of San Francisco (FRBSF) issued an research report titled as "Coronavirus and the Risk of Deflation". In this report, FRBSF analyzes as below.

"The pandemic caused by COVID-19 represents an unprecedented negative shock to the global economy that is likely to severely depress economic activity in the near term. The coronavirus shock may reduce aggregate demand enough to lower the U.S. inflation rate by as much as 2 percentage points. We fbcus on the risk of a significant drop in inflation from its current level. To assess this risk, we use yield curve models of nominal and real government bond yields from four major countries: Canada, France, Japan, and the United States and general corporate purposes."

According to the economy outlook of FRBSF as above, the term structure of interest rates will most likely be:

A.upward sloping.

B.flat.

C.humped.

D.downward sloping.

E.double-humped.

Answer 1

When there is an expectation of an impending recession and slowing of the demand because of lack of the disposable income which can be reflected through decrease in the overall inflation of the country,there is a signalling of inverted yield curve, because in such scenario, the short term bond yield is trading above the long term bond yield.

So this is a representation of downward sloping yield curve in which the short term bond yields are trading above the long term bond yields because of demand slow down and lack of inflation.

This is not a flat or humped or upward-sloping or double humped yield curve.

Correct answer would be option (d) downward-sloping