Exchange Rate Growth and Sovereign Treasury Bond Yield Curve Movements in Kenya

Abstract

This paper investigates the dynamic relationship between exchange rate movements and long-term sovereign treasury bond yield curve dynamics in Kenya, with particular emphasis on the moderating role of monetary policy. Using quarterly data and a Vector Autoregression (VAR) framework, the study examines both direct and indirect transmission channels through which exchange rate shocks influence government bond yields. Unit root tests confirm that all variables are stationary in levels, justifying estimation of a VAR (1) model. Empirical results indicate that exchange rate shocks do not exert a strong immediate effect on bond yields; instead, their influence is transmitted indirectly through monetary policy responses, as reflected in adjustments to the Central Bank Rate (CBR). Impulse response analysis shows that exchange rate depreciation induces a tightening monetary policy stance, which subsequently affects yield curve movements. The findings underscore the importance of exchange rate stability and credible monetary policy coordination in managing sovereign borrowing costs in emerging market economies.