The yield curve as a predictor of economic activity in Mexico: the role of the term premium

This paper analyzes whether there exists a relationship between the slope of the yield curve and future economic activity in Mexico for the period 2004-2019. In particular, we evaluate whether such relationship depends on the term premium. For this purpose, we estimate a threshold model in which the relationship between the yield spread and future economic activity, measured as either output growth or the probability of a contraction, depends on whether the term premium is above or below an estimated threshold. The main results indicate that the slope of the yield curve seems to anticipate the behavior of economic activity only when the term premium is above a threshold. Our results also suggest that the slope of the yield curve has predictive power over the probability of facing a contraction in the future only when the term premium is above a threshold. The estimated value for such threshold depends on the forecast horizon and the measure of economic activity.