Final answer:
An upward sloping yield curve, as per the expectation hypothesis, indicates that interest rates are expected to rise in the future. If a country's currency is expected to appreciate, yields on government bonds typically fall due to increased foreign demand. Inflation expectations also dictate interest rates, with higher expected inflation leading to higher rates and vice versa.
Step-by-step explanation:
According to the expectation hypothesis, an upward sloping yield curve implies that interest rates are expected to increase in the future. This hypothesis is grounded on the idea that long-term interest rates are the average of current and future short-term interest rates. If investors anticipate that interest rates will rise, they will require higher yields for longer-term bonds to compensate for the expected increase in rates, resulting in an upward sloping yield curve.
If a country's currency is expected to appreciate in value, expected exchange rates are likely to have an impact on yields. Specifically, if the currency is expected to strengthen, foreign investors might increase demand for that country's bonds, anticipating higher returns when converting back to their own currency. This increased demand can drive bond prices up and yields down. Hence, if a currency is expected to appreciate, we could expect the interest rates on government bonds in that country to decrease, in order to balance demand and supply for these financial instruments.
In the context of inflation expectations, when the public expects higher inflation, they anticipate that the central bank may implement contractionary monetary policy, leading to higher interest rates. Conversely, if lower inflation is expected, it can be indicative of an impending recession, prompting expansionary monetary policy and potentially lower interest rates in the short term.