The Impact of Yields Abroad and the Public Debt on Real Yields of Israeli Government Bonds: A Reexamination
An excerpt from Selected Research and Policy Analysis Notes to be published soon:
- Real yields on Israeli government bonds are more closely and more significantly correlated with real yields in the eurozone than with parallel yields in the US. This correlation has intensified since the global financial crisis began, and strengthens with the lengthening of the bond horizon.
- A decline in the public debt to GDP ratio leads to a significant and notable decline in government bond yields. This impact has grown considerably since the global financial crisis began. The data that were known about the ratio in real time (when yields were determined by the market) explain the yields better than the updated data received later.
Research written by Gilad Shalom of the Bank of Israel Research Department and that will be published in the forthcoming “Selected Research and Policy Analysis Notes” by the Bank of Israel examines the factors impacting on government bond yields in Israel for terms ranging from 1 year to 10 years. The research updates previous research by Brender and Ribon (2014) and adds two new explanatory variables: 1. eurozone yields and 2. the debt to GDP ratio that was known when the yields were determined in the market.
The research finds that real yields in Israel have a strong and significant correlation with real yields in the eurozone, and that this correlation intensified since the outbreak of the global financial crisis. An increase of 1 percentage point in the real yield in the eurozone is associated with an increase in Israel of 0.2 percentage points for a term of 1 year, strengthening gradually to 0.5 percentage points for a 10 year term. This strength is double the effect measured before the outbreak of the crisis. The strong correlation between yields in Israel with those in the eurozone apparently reflects the notable connection between economic activity in Europe and in Israel, and not just financial effects.
The research also found that when the correlation between yields in Israel and in the eurozone is taken into account, a statistically significant connection cannot be seen between yields in Israel and the US. An exception is for the short term, in which US yields are correlated with the Bank of Israel interest rate, through which they impact on capital market yields. This finding is important, as in many analyses of the yields in Israel, the US yield is generally used as a benchmark for the global environment. The strong and increasing correlation between Israel and Europe indicates that the increasing complexity of Israel’s economic ties due to globalization processes requires referring extensively to developments in Europe as well. With that, it should not be concluded from the findings that US economic developments do not impact on Israeli capital market yields, but that this impact is already markedly captured in eurozone yields.
The ratio of public debt to potential GDP has a marked impact on yields, and this impact has also intensified since the outbreak of the global financial crisis. The research finds that since 2009, a decline of 1 percentage point in the debt ratio reduces the yields on government bonds by 0.08 to 0.1 percentage points, with the strength of the impact increasing with the term to maturity. This intensity is triple, or more, what was measured before the crisis. The research found that using debt to GDP ratio data that were known to investors at the time the yields were determined in the market improves the estimation relative to using data as they were measured retroactively, after the updates to GDP data by the Central Bureau of Statistics. The results indicate that when examining economic and financial developments in retrospect, it is important to consider the information that investors and policy makers had available in real time, even if the data changed retroactively.
An analysis conducted using equations estimated in the paper indicates that the continued decline in the debt to GDP ratio and the decreases in eurozone yields explain a considerable part of the declines in yields on Israeli government bonds, particularly for longer terms. For example, out of a decline of 4.6 percentage points in the real yield on 10-year bonds between 2001 and 2017, the decline in the debt ratio explains 1.6 percentage points, mostly until 2013, and the decline in eurozone yields explains 1.8 percentage points.