What type of situation is associated with a flat yield curve?

A flat yield curve indicates that there is little difference between short-term and long-term interest rates. This situation can arise during periods where the market is uncertain about future economic growth, which often corresponds with a potential recession. When investors expect slower growth or a downturn, they may demand similar yields for both short-term and long-term bonds, reflecting their lack of confidence in the economy's prospects.

In a flat yield curve environment, the typical expectation of higher yields for longer-term investments due to increased risk does not hold. This can signal that investors are seeking safety in long-term bonds, anticipating that economic conditions may deteriorate. Often, central banks might also be holding interest rates steady (not changing them significantly), contributing to this flat curve. Thus, it reflects a cautious outlook on the economy and aligns with the characteristics of a potential recession.