Abstract
M.Comm. (Financial Economics)
The term structure of interest rates, particularly the term spread determined from the
difference between ten-year government bond yields and three-month Treasury bill
yields, has received increased attention as a valuable forecasting tool for the purposes
of monetary policy and recession forecasting. This is on the back of the observed
positive relationship between term spread and economic activity. Moreover, the term
spread has been observed to invert prior to the occurrence of economic recessions both
in developed and developing countries.
This study investigated the forecasting ability of the South African (S.A.) term spread in
predicting S.A. recessions, taking into account the recent global economic recession.
The reason behind the investigation is due to the forecasting consistencies illustrated by
the term spread in providing statistically incorrect signals of recession in 2003, which did
not transit into reality. It implied a weak relationship between the S.A. term spread and
economic activity. Moreover, based on observations from the literature that term
spreads and economic activities across countries are correlated, the term spreads of
China, United States (U.S.) and Germany were investigated and compared to the S.A.
term spread, to determine which better forecasts S.A. recessions. The study employed
the Dynamic Probit Model, since it is considered to provide a better predictive edge over
the Traditional Static Probit model.
The findings revealed that the S.A. term spread accurately predicted all the S.A
recessions since 1980; Chinese term spread accurately predicted the 1996 and 2008
S.A recessions; U.S. term spread predicted some recessions; while German term
spread predictions were countercyclical.