Which of the following scenarios is most likely to result in an inverted yield curve?

Question: Which of the following scenarios is most likely to result in an inverted yield curve?

Answer options:

• Periods of strong economic growth and low inflation. ✅ Aggressive monetary policy tightening by the central bank to combat high inflation.
• A stable economic outlook with moderate inflation.
• Fiscal stimulus measures leading to increased government borrowing.

Correct answer: Aggressive monetary policy tightening by the central bank to combat high inflation.

Explanation: An inverted yield curve, where short-term rates are higher than long-term rates, often signals an impending economic recession. This typically occurs when a central bank aggressively raises short-term rates to curb inflation, leading investors to expect slower growth and lower rates in the future, thus demanding lower compensation for longer-term risks.