“The empirical results obtained in this paper indicate that a yield-only model tends to overpredict the level of yields across the spectrum except 6-8 years maturities segment,” RBI said.
Comparing actual yields for the second quarter of this year (up to June 10) with the forecasts, the yield-macro model point to the scope for yields to adjust upwards by 1-23 bps in the 2-3 years maturity segment and downwards by 39-56 bps in the 6-9 years segment.
In the July-September quarter, the estimates show that there is further scope for the 10-year yield to ease from current levels. These evolving yield curve dynamics suggest the scope for open market operations and the points on the yield curve to which they need to be targeted.
Investigating the steepening of India’s yield curve reveals, that yields across the maturity spectrum have declined, but more at the short end than at the longer end.
“Thus, monetary policy has been effective in pulling down and anchoring short-term interest rates which, in turn, facilitated the easing of rates right up to two years maturity even below the policy rate,” RBI paper said.
On the other hand, transmission to longer rates was lagged and less complete, leading to an increase in the term premium and a steepening of the yield curve. While the association between central bank liquidity and shorter-term yields shows a distinct inverse relationship, this co-movement is not so clear in the case of longer-term yields
The papers worked on a model called “the yield-only model”, which it uses as a benchmark to evaluate the gains in accuracy when augmenting it with macroeconomic variables described earlier in a yield-macro model. The model allows the dynamic two-way interaction of macro variables with the structure of the yield curve with feedback.
It finds the 5-year yield to be fairly valued and the 10-year yield converging to fair value in the second quarter this year.
