Yield Spreads, The Exchange Rate, and Recession Predictability for Northern Mexico Border Economies

Abstract

Article History JEL Classification:E32, Business cycles, E43, Interest rates, R15, Regional econometric models.Prior research suggests that the yield spread between long-term and short-term interest rates contains information regarding the likelihood of future recessions. Linkages between the yield spread and regional business cycles in emerging economies have, to date, received little attention. This study employs yield spreads for Mexico and for the United States, as well as a real exchange rate index, as potential predictors of recessions in eight metropolitan economies located in northern Mexico. The results suggest that, in most cases, the United States yield spread provides early warning signals of potential economic downturns, as does the real exchange rate index. Contribution/Originality:This study contributes to the existing literature on yield curves and recession predictability by amplifying the framework to include a currency market measure as well as international interest rate variables. It is one of very few studies that have applied this methodology to border region metropolitan economies.

Business Cycle Downturn Likelihood Estimation for Ciudad Juarez

“…The negative sign indicates that an inverted yield curve in Mexico is followed, 14 months later, by a recession in Ciudad Juarez. That runs counter to what is documented using quarterly data over a shorter time span in Fullerton and Sáenz-Rojo (2018). Fluctuations in the real exchange rate index also impact the business cycle in this northern Mexico urban economy.…”

“…Both Mehl (2009) and Reyna Cerecero, Salgado Cavazos, and Salazar Bando (2008) find that the United States yield spread has significant predictive power for the Mexican economy. It has also been found to help predict recessions using quarterly data for the eight city pairs located along the border from the United States (Fullerton, Sáenz-Rojo, and Walke, 2017;Fullerton and Sáenz-Rojo, 2018). A real exchange rate index (𝑅𝐸𝑋) is also included as an explanatory variable because of the importance it plays in border region business cycles in Mexico (Fullerton, 2003).…”

“…This is especially true for Latin American urban economies where time series data are not available for many indicator variables such as housing prices (Christiansen, Eriksen, and Moller, 2019;Gianetti, 2021), digital activity (Mossberger et al, 2023), consumer confidence (Biolsi and Du, 2020), gross metropolitan product (Koop et al, 2020), or retail sales fluctuations (Downs and Fullerton, 2017). Historically, two or more quarters of declining employment has been utilized as the criterion for identifying metropolitan downturns (Fullerton and Sáenz-Rojo, 2018). That pattern did not occur during the Covid-19 recession and substantial regional heterogeneity has been documented for that contraction (Connaughton, Cebula, and Amato, 2023).…”

“…(FRED, 2023). The economic and geographic adjacencies of Ciudad Juarez to the United States make it highly sensitive to financial and economic developments (Fullerton, 2003;Fullerton and Sáenz-Rojo, 2018). An inverted yield curve is frequently associated with both national and regional economic recessions (Dueker, 1997;Gauger and Schunk, 2002;Shoesmith, 2003).…”

“…Downturn probability studies for low-and middle-income economies are far less numerous. That is particularly true for regional and metropolitan economies in less prosperous countries (Fullerton and Sáenz-Rojo, 2018).…”