In what situation would the yield on less safe bonds remain higher than that of AAA bonds?

The yield on less safe bonds remaining higher than that of AAA bonds is typically a reflection of investor perceptions regarding risk. When investor confidence is low, market participants become more apprehensive about the financial health of issuers, particularly those with lower credit ratings. As a result, they demand a higher yield to compensate for the additional risk of default associated with lower-rated bonds compared to higher-rated AAA bonds. The yield spread between these securities often widens during periods of uncertainty, ensuring that the riskier bonds must offer more attractive yields to entice investors who are worried about potential losses.

High investor confidence, on the other hand, tends to lead to a flight to safety, where investors prefer higher-rated securities like AAA bonds, thereby reducing their yield. Rising interest rates can influence bond yields generally but do not inherently create a situation where the yield on less safe bonds remains distinctively higher than that of AAA bonds. Similarly, a stable economy usually boosts confidence, narrowing the yield gap between different tiers of bond credit quality as investors feel more secure in their investments.