Assuming that liquidity and interest rate expectations are both important for explaining the shape of a yield curve, what does a flat yield curve indicate about the market’s perception of future interest rates?

A flat yield curve indicates that there is perception that there will be little difference in the future short term interest rate and long term interest rate.

Explanation:

Yield curves are used to illustrate yield of a bond over a period of time. It is illustrated graphically in the attached.

It gives an idea of variations in short term and long term rates in the future.

A rising yield curve indicates that investors will get higher yield as time goes on.

However when the grid curve is flattening it means there is no foreseeable increase in yield in the future.

Flattening of yield curve occurs when there is anticipation of slow economic growth.

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