An analysis of UK swap yields

Abstract

John Maynard Keynes argued that the central bank influences the long-term interest rate through the effect of its policy rate on the current short-term interest rate. However, Keynes’s claim was confined to the behavior of the long-term government bond yield. This paper investigates whether Keynes’s claim holds for the yields of spread products and over-the-counter financial derivatives by econometrically modeling the dynamics of the pound sterling (GBP)–denominated long-term interest rate swap yield. It uses the generalized autoregressive conditional heteroskedasticity modeling approach to examine the relationship between the month-over-month change in the current short-term interest rate and the month-over-month change in the long-term swap yield, while controlling for several key macroeconomic and financial variables. The month-over-month change in the current short-term interest rate has a positive and statistically significant effect on the month-over-month change in the long-term swap yield. This finding reinforces and extends Keynes’s conjecture concerning the central bank’s influence over the long-term interest rate. The investigation’s empirical findings and their policy implications are discussed from a Keynesian perspective.

Keywords:

• Interest rate swaps
• swap yields
• interest rates
• Bank of England
• John Maynard Keynes

JEL Classifications:

• E43
• E50
• E58
• E60
• G10
• G12

Acknowledgement

The authors thank participants at various workshops, the editor, the guest editors of the special issue in honor of late Professor Tracy Mott and the two anonymous referees for their invaluable comments. They also thank Ms. Elizabeth Dunn for her copyediting support. This paper was presented at the 1st annual Professor Tracy Mott Economic Theory and Policy Workshop at the University of Denver in Denver, Colorado (September 23–24, 2022). An earlier version of the paper was a published in the Levy Institute’s working paper series. The authors’ institutional affiliations are provided solely for identification purposes. Views expressed are merely those of the authors.

Disclosure statement

The standard disclaimer holds.

Data availability statement

The dataset used in the empirical part of this paper is available upon request to bona fide researchers for the replication and verification of the results.

Notes

1 However, it must be said that during the sterling crisis of 2022, when both the short-term interest rate and the long-term gilt yield rose while the GBP depreciated, the swap yields rose (Luhnow, Thomas, and Colchester 2022). Clearly the effect of a higher short-term interest rate on the swap yield dominated over the GBP’s deprecation.

2 Although the sum is slightly higher than one (1) for 2-year swap rates.

3 Results are available upon request.

Additional information

Funding

This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Notes on contributors

Tanweer Akram

Tanweer Akram is a Senior Vice President/Senior Economist at Citibank.

Khawaja Mamun

Khawaja Mamun is an associate professor at Jack Welch College of Business & Technology, Sacred Heart University (SHU).