The Role of Economic and Policy Uncertainty on the Effects of Widening Budget Deficits on Yields and the Credit Default Swap Spreads

What are the effects of economic and policy uncertainty on government bond yields and the credit default swap spreads? Furthermore, does economic and policy uncertainty propagate the effects of widening budget deficits on ten-year yields and the credit default swap spreads? We find that positive shocks to the global economic and policy uncertainty (GEPU) index are transmitted into the South African economic and policy uncertainty (SAEPU) index, but a large share of the variation in the SAEPU is due to domestic factors. Furthermore, the five-year credit default swap (CDS) spreads and the ten-year government bond yields increase due to positive shocks to the SAEPU index. The counterfactual results show that the SAEPU channel amplifies the impact of the positive shocks on the budget deficit on the five-year CDS spreads and the ten-year government bond yields. In the absence of the SAEPU channel, the five-year CDS spreads and the ten-year government bond yields increase less due to the positive shocks on the budget deficit. The results imply that the widening budget deficits and heightened domestic uncertainty amplify the increase in the five-year CDS spreads and the ten-year government bond yields. It is therefore important to reduce domestic economic and policy uncertainty.