The term structure of interest rates and economic activity: Evidence from the COVID-19 pandemic

This paper tests the accuracy and predictability of two term structure models using both yields-only and factor-augmented specifications focusing on the recent COVID-19 crisis. In addition, we test the predictive ability of the yield curve on economic activity for the United States and other advanced countries. We provide evidence that models with an enhanced information set, including COVID-19 factors, improve interest rate forecasts for this period. Also, we point out that term structure models can determine future variations in economic activity but are time- and country-sensitive. Finally, out-of-sample analysis reveals that the use of factor-augmented term structure models, to reflect the current economic and market conditions, improves their forecasting accuracy.