What is the primary risk associated with a steepening yield curve?

The primary risk associated with a steepening yield curve is interest rate risk. A steepening yield curve indicates that long-term interest rates are increasing faster than short-term rates, which often reflects expectations of higher inflation or stronger economic growth. This situation can impact bond prices negatively since bond prices and interest rates move inversely.

When interest rates rise, the prices of existing fixed-income securities decline. Investors holding bonds are directly exposed to this risk because the market value of their assets decreases as new bonds are issued with higher yields. This scenario is particularly concerning for long-duration bonds, as they are more sensitive to changes in interest rates compared to short-duration bonds.

While credit, liquidity, and market risks are relevant in other contexts, they do not specifically relate to the dynamics presented in a steepening yield curve scenario. Credit risk pertains to the possibility of the bond issuer defaulting, liquidity risk relates to the ease of buying or selling an asset without affecting its price, and market risk encompasses the potential for losses due to overall market movements. However, in the context of a steepening yield curve, interest rate risk stands out as the primary concern for investors.