Yield spreads as predictors of industrial production: expectations on short rates or term premia?
This paper reconsiders information in the US T-bill term structure for predicting movements in real monthly industrial production. It is shown that although T-bill spreads contain little or no predictive content, increases in term premia estimated from a GARCH-M model of the term structure do. Since these estimated premia are linear functions of the conditional variance of excess returns, the implication is that increases in interest rate variability are associated with reductions in industrial production. This evidence is robust to the inclusion of the spread between the 10-year Tbond yield and one-month-T-bill yields. The T-bill term structure therefore contains information which is independent of the long-end of the term structure.