Web Manual of Loans Tips

Many government bond investors believe that deviations of treasury yield curve steepness from the traditional range or a fair value obtained by regression analysis are only temporary. That is, they expect yield curve steepness to be mean reverting. From a theoretical point of view there is strong support for this hypothesis. In the early stages of the business cycle, that is at the beginning of an expansion, monetary policy is easy and shortterm interest rates are still low. But an improving outlook for future economic growth leads to rising long-term interest rates and a steeper yield curve. The later stages of the expansion are characterized by rising inflationary pressures and consequently central bank tightening. The most  impressive example for this experience were the seven interest rate hikes by the Fed between January 1994 and January 1995, that led to a sell-off in the treasury market and were accompanied by a massive flattening of the yield curve. When the tighter monetary policy begins to unfold its influence on price growth, this is usually followed by weakening economic growth. In this economic environment yield curves steepen again, because short-term interest rates tend to price in room for central banks to cut interest rates.