The nexus between the yield curve and economic activity: Empirical evidence from emerging markets (EMs)

The yield curve has been widely considered a powerful predictor of economic activity. This study primarily looks at the nexus between the yield curve and economic activity, using the latent factor approach, to study nine (9) MSCI Emerging Markets. Monthly data, covering the period from November 2007 to June 2022 (2007:M11 to 2022:M06), are employed. The main objective is to study the relationship between the yield curve and economic activity. The specific objectives include, for instance, how the spread impacts economic activity when controlled for the local stock markets, i.e., the All Share Index (ASI) or Composite Index (CI); how the spread impacts economic activity when controlled for an international stock market index, i.e., the iShares MSCI Emerging Markets Index (MSCI); and how the spread impacts economic activity when controlled for an alternative international or global benchmark like the global oil price, i.e., the West Texas Intermediate (WTI). The Fully-Modified OLS (FMOLS), Dynamic OLS (DOLS), and Canonical Cointegrating Regression (CCR) estimators are respectively employed to test for the long-run heterogeneous relationship between the yield curve and economic activity. Among other things, it is found that the spread is negatively related to the economic activity, which is represented by the industrial production index, suggesting that, in the long run, an inverted yield curve retards the economic activity of the MSCI Emerging Markets. The result is robust to both the international equity index and the global oil price. Among other things, it is recommended that the 10-year long-term bond rate could be replaced with the 5-year long-term bond rate to check the accuracy of the yield spread in predicting the economic activity of the MSCI Emerging Markets. Keywords: Economic Activity, Long-run Relationship, MSCI Emerging Markets, Panel Data, Yield Curve.