The Yield Curve as a Predictor and Emerging Economies

Abstract

Conclusions 27References 30 Figures and tables 34European Central Bank Working Paper Series 53 ABSTRACTThis paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and the euro area yield curves help to predict. It finds that the domestic yield curve in emerging economies has in-sample information content even after controlling for inflation and growth persistence, at both short and long forecast horizons, and that it often improves out-of-sample forecasting performance. Differences across countries are seemingly linked to market liquidity. The paper further finds that the US and the euro area yield curves also have in-and out-of-sample information content for future inflation and growth in emerging economies. In particular, for emerging economies that have an exchange rate peg to the US dollar, the US yield curve is often found to be a better predictor than these economies' own domestic curve and to causally explain their movements. This suggests that monetary policy changes and short-term interest rate pass-through are key drivers of international financial linkages through movements from the low end of the yield curve. Non-technical summaryThis paper investigates the extent to which the slope of the yield curve in emerging economies predicts domestic inflation and growth. It also examines international financial linkages and how the US and the euro area yield curves help to predict.To this end, the paper uses a sample of 14 emerging economies to investigate the usefulness of their domestic slope of the yield curve to forecast inflation and growth over the last decade. It finds that the yield curve has information content in almost all countries, even after controlling for inflation and growth persistence, at both short and long forecast horizons. On average, insample results suggest that, further to a 100 basis points steepening in the domestic yield curve observed a year and a half ago, both inflation and growth are expected to accelerate by around 30basis points a year ahead. Differences across emerging economies are seemingly linked to market liquidity.In examining international financial linkages, the paper assesses the ability of the slope of the US or the euro area yield curve to help predict inflation and growth in emerging economies. It finds that the US and the euro area yield curves also have in-and out-of-sample information content for future inflation and growth in these economies. On average, in-sample results suggest that, further to a 100 basis points steepening in the foreign yield curve observed a year and a half ago, emerging market inflation is expected to accelerate by around 60 basis points a year ahead, against 2 percentage points for growth. There is evidence that differences across emerging economies are linked to the exchange rate regime, controlling for relative market liquidity and commonalities in economic shocks. In particular, for those econo...

Yield Curve Dynamics: Regional Common Factor Model

“…We fi nd that the HUF yield curve loads the most on both regional factors and these loading coeffi cients are signifi cant, whereas the CZK level factor loads the least on the regional factors. Additionally, we confi rmed that zloty's slope factor behave to a large extent independently of regional slope factor, which Mehl (2009) explains by stronger link to the USD yield curve. Moreover, the SKK yield curve dynamics does not load on the regional slope factor at all, yet the regional level factor explains over 75% of the variance of the SKK level factor.…”

“…There are several studies that deal with cross country yield-curve dynamics based on dynamised Nelson-Siegel framework (e.g. Mehl, 2009or Hoffmaister et. al, 2010, however, this paper takes a different approach and models regional common dynamics for all considered countries together.…”

“…7 In contrary to the level factor, the PLN yield curve slope behaves differently than the regional slope factor. Mehl (2009) fi nds that the Polish yield curve slope is mainly linked to the USD yield curve slope. Also, the SKK slope factor is explained by the regional slope factor by less than 1%.…”

Asset Prices and Macroeconomic Outcomes: A Survey

“…Some studies find a weak effect for (financially) constrained households and a stronger impact for non-constrained ones. Vissing-Jørgensen (2002), for example, reports the elasticity of intertemporal substitution to be close to 71 Mehl (2009) reviews the literature on the predictive ability of the yield curve in EMEs and shows that, depending on the extent of market liquidity, it has informational value for future inflation and growth.…”

Sustainable Local Currency Debt: An Analysis of Foreigners’ Korea Treasury Bonds Investments Using a LA-VARX Model

“…Estrella and Mishkin [64] calculated the likelihood that the U.S. economy would enter a recession due to short-and long-term interest rate differentials. Mehl [65] obtained positive results using short-term and long-term U.S. interest rate differentials to test economic forecasts for emerging economies.…”