Final answer:
A sharply rising yield curve typically indicates that inflation is starting to increase or is expected to rise, as lenders demand higher interest rates to compensate for future inflation.
Step-by-step explanation:
When the yield curve begins to rise sharply, it usually indicates that inflation is starting to increase, or is expected to do so in the near future. This assertion aligns with economic principles that suggest when an economy is operating close to or at its potential GDP, there will be rising price levels or inflationary pressures, while maintaining a low unemployment rate. Consequently, as inflation expectations rise, lenders demand higher interest rates to compensate for the decreased purchasing power of future interest payments, which in turn causes the yield curve to steepen.
The other options listed do not correctly interpret the signal conveyed by a sharply rising yield curve. For example, option 1 suggests a relationship with stock returns and a recession, but this is not directly indicated by the steepening of the yield curve. Option 2's reference to inflation rates peaking is also incorrect, as a steep yield curve points to increasing inflation rates rather than a peak. Finally, while bond prices move inversely to yields, a rising yield curve implies expecting bond prices to decrease in the future, making option 3 incorrect as well.