If the risk premium on bonds increases, what does that likely indicate for future economic activity?

An increasing risk premium on bonds suggests that investors are requiring higher compensation for taking on additional risk associated with those bonds. This typically occurs during periods of uncertainty or economic instability, where investors become more risk-averse and demand higher yields to compensate for the perceived increased likelihood of default or other risks. When the risk premium rises, it often signals that market participants are concerned about the overall direction of the economy, anticipating potential downturns or recessionary conditions.

This behavior reflects broader economic sentiments; as risk perceptions grow, businesses and consumers may become cautious, which can lead to reduced investment and spending. An increase in the risk premium can, therefore, be interpreted as a warning sign of potential economic challenges ahead, aligning with the notion that an economic downturn might be forthcoming.