The drivers of an upward-sloping curve are more ambiguous. the existence of bond risk premiums that are positively related to maturity means that an upward-sloping curve may not embody expectations of future rate increases. Conversely, it could imply a combination of expected rate increases and risk premiums, or even expected rate cuts that are more than offset by the existence of positive risk premiums.
can someone explain this why upward sloping curve Expectations relating to the future direction of interest rates are indeterminate?
Maturity risk is a fact (in a normal market scenario). I mean, if a lender accepts to lend money for a term of 10 years, she will require a risk premium over an interest rate of a similar loan but for 1 year maturity. So, we can be sure an upward sloping interest rate curve is capturing the maturity risk premiums along the curve. However, if you were able to retire the effect of all those maturity risk premiums along the curve and the resulting curve is still upward sloping, then you can conclude there is an expectation of future rate increases. If the resulting curve is flat, then the market is not expecting future rate increases. Without this math calculation you can’t conclude exante if an upward sloping curve is expecting future interest rate increments.
We can even have a third case where the resulting curve (after retiring maturity risk premiums) is downward sloping (implying future rate decreases), but just because the maturity risk premiums have higher effect the full curve is upward sloping. This is why it is ambiguous. Crazy, hehe.
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