Chartered Financial Analyst (CFA) Practice Exam Level 2

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In the context of yield curves, what does bullish flattening indicate?

LT rates rise more than ST rates
LT rates fall more than ST rates
Higher spread between ST and LT rates
Increasing gap between ST rates

The correct answer is: LT rates fall more than ST rates

Bullish flattening refers to a scenario where long-term interest rates decrease at a faster rate than short-term interest rates, leading to a reduction in the steepness of the yield curve. When investors expect economic growth and lower rates, they are likely to buy long-term bonds, pushing their prices up and yields down. At the same time, short-term rates might remain stable or decline only gradually, resulting in long-term rates falling more significantly. This dynamic suggests that the market anticipates a positive economic outlook, but with caution concerning short-term rates, which usually reflect current monetary policy and immediate economic conditions. Thus, in instances of bullish flattening, the overall yield curve indicates a market consensus of steady or improving future economic conditions despite a retreat in longer-term rates relative to shorter ones.