How Does Inflation in Advanced Economies Affect Emerging Market Bond Yields? Empirical Evidence from Two Channels

HOWDOESINFLATION INADVANCEDECONOMIESAFFECTEMERGINGMARKETBONDYIELDS? EMPIRICALEVIDENCEFROMTWOCHANNELS Sei-WanKim,DonghyunPark,andShuTian NO.695 September2023 ADBECONOMICSWORKINGPAPERSERIES ASIANDEVELOPMENTBANK ADBEconomicsWorkingPaperSeries HowDoesInflationinAdvancedEconomiesAffectEmergingMarketBondYields?EmpiricalEvidencefromTwoChannels TheADBEconomicsWorkingPaperSeriespresentsresearchinprogresstoelicitcommentsandencouragedebateondevelopmentissuesinAsiaandthePacific.TheviewsexpressedarethoseoftheauthorsanddonotnecessarilyreflecttheviewsandpoliciesofADBor itsBoardofGovernorsorthegovernmentstheyrepresent. Sei-WanKim,DonghyunPark,andShuTianNo.695|September2023 Sei-WanKim(swan@ewha.ac.kr)isaprofessorofeconomicsattheEwhaWomansUniversity,Seoul.DonghyunPark(dpark@adb.org)isaneconomicadvisorandShuaTian(stian@adb.org) isasenioreconomistattheEconomicResearchandDevelopmentImpactDepartment, AsianDevelopmentBank. ASIANDEVELOPMENTBANK CreativeCommonsAttribution3.0IGOlicense(CCBY3.0IGO) ©2023AsianDevelopmentBank 6ADBAvenue,MandaluyongCity,1550MetroManila,PhilippinesTel+63286324444;Fax+63286362444 www.adb.org Somerightsreserved.Publishedin2023. ISSN2313-6537(print),2313-6545(electronic)PublicationStockNo.WPS230372-2 DOI:http://dx.doi.org/10.22617/WPS230372-2 TheviewsexpressedinthispublicationarethoseoftheauthorsanddonotnecessarilyreflecttheviewsandpoliciesoftheAsianDevelopmentBank(ADB)oritsBoardofGovernorsorthegovernmentstheyrepresent. ADBdoesnotguaranteetheaccuracyofthedataincludedinthispublicationandacceptsnoresponsibilityforanyconsequenceoftheiruse.ThementionofspecificcompaniesorproductsofmanufacturersdoesnotimplythattheyareendorsedorrecommendedbyADBinpreferencetoothersofasimilarnaturethatarenotmentioned. Bymakinganydesignationoforreferencetoaparticularterritoryorgeographicarea,orbyusingtheterm“country”inthispublication,ADBdoesnotintendtomakeanyjudgmentsastothelegalorotherstatusofanyterritoryorarea. ThispublicationisavailableundertheCreativeCommonsAttribution3.0IGOlicense(CCBY3.0IGO)https://creativecommons.org/licenses/by/3.0/igo/.Byusingthecontentofthispublication,youagreetobeboundbythetermsofthislicense.Forattribution,translations,adaptations,andpermissions,pleasereadtheprovisionsandtermsofuseathttps://www.adb.org/terms-use#openaccess. ThisCClicensedoesnotapplytonon-ADBcopyrightmaterialsinthispublication.Ifthematerialisattributedtoanothersource,pleasecontactthecopyrightownerorpublisherofthatsourceforpermissiontoreproduceit.ADBcannotbeheldliableforanyclaimsthatariseasaresultofyouruseofthematerial. Pleasecontactpubsmarketing@adb.orgifyouhavequestionsorcommentswithrespecttocontent,orifyouwishtoobtaincopyrightpermissionforyourintendedusethatdoesnotfallwithintheseterms,orforpermissiontousetheADBlogo. CorrigendatoADBpublicationsmaybefoundathttp://www.adb.org/publications/corrigenda ABSTRACT Increasingoilandfoodpricesandpersistentsupplychaindisruptionsin2022contributedtoinflationinadvancedeconomiesthathadnotbeenseenindecades.Thispushedupinterestrates,whichinturnledtohigheryieldsinglobalbondmarkets.Thisstudyexaminestwodistinctchannelsthattransmitadvancedeconomyinflationtoemergingmarketbondyieldsbyemployinganovelmultivariablesmoothtransitionautoregressive–vectorautoregressive(STAR-VAR)model.Ourempiricalanalysisyieldstwonewkeyfindings.First,advancedeconomyinflationhasasignificanteffectonregimechangesbetweenexpansionandcontractioninemergingmarketbondyields.Second,theshort-runeffectofadvancedeconomyinflationonthebondyieldsofemergingmarketsisasymmetricbetweentheexpansionandcontractionregimes.Theeffectismostlypositiveinbothregimesbutstrongerinabondyield’scontractionregime.ThissuggeststhattheresponseofemergingmarketbondyieldstoadvancedeconomyinflationdoesnotnecessarilyfollowasimpleFisherequationrelationship. Keywords:bondyields,inflation,advancedeconomy,emergingmarket,regimechange,smoothtransitionautoregressivemodel JELcodes:F14,C40,C51 1.Introduction Thisstudyhelpstofillagapintheliteraturebyempiricallyexaminingwhetherandhowadvancedeconomyinflationaffectsemergingmarketbondyields.Specifically,weinvestigatehowinflationintheUnitedStates(US),Japan,andGermanyisassociatedwithyieldsonlocalcurrencybondsinsevenAsiaandthePacificeconomiesforwhichbondmarketdataareavailable:thePeople’sRepublicofChina(PRC);HongKong,China;Indonesia;theRepublicofKorea;Malaysia;thePhilippines;andThailand. Sincethecoronavirusdisease(COVID-19)pandemic,advancedeconomieshavebeenexperiencingrecord-highinflation(Figure1).Thishaspromptedcentralbankstohikepolicyrates,whichthenpushesupshort-terminterestrates.Inaddition,highinflationcauseslong-terminterestratestorisereflectingchangesinexpectedfutureinterestrates,inflation,andinflationriskpremiums(Duffee2018;Joyceetal.2010).Inflationimpliesgreateruncertaintyabouteconomicgrowthandhigherriskaversion,whichalsopushesupbondyields(BekaertandEngstrom2010). Figure1:AverageInflationRateinMajorAdvancedEconomiesandAverageInflationRateinDevelopingAsianEconomies,January1990–October2022 Notes:ThesolidlinerepresentstheUnitedStates,J