The Effect of Inflation on Yields of Treasury Bonds in Kenya

Abstract

The study sought to understand how changes in inflation rates impact the yields offered by government bonds. The inspirationto undertake the studycame from the recognition that inflation is a critical economic factor that affects investment decisions and monetary policy, and its interaction with bond yields is a topic of substantial interest to investors, policymakers, and financial analysts. The study endeavored to explore and analyze the nature of this relationship within the Kenyan context, addressing a pertinent issue in the country's financial landscape.A descriptive research design was employedduring the study, where monthly data for each study variable was collected for the period 2013-2022. Correlation and regression analyses were utilized to determine associations between variables. The resultsrevealed that there was a moderately positive correlation between bond yields and inflation, as well as a positive correlation with interest rates. Conversely, bond yields displayed a strong negative correlation with GDP, implying that as GDP grew, bond yields tended to decrease. Market Capitalization displayed a moderately positive correlation with bond yields, while the debt-to-GDP ratio did not exhibit a significant relationship. The regression analysis exhibited that the overall model explained a substantial portion of the variance in bond yields, with an R-squared value of 0.225. Among the independent variables, inflation emerged as a significant predictor of bond yields, with a positive coefficient and statistical significance. However, interest rates, GDP, Market Capitalization, and the debt-to-GDP Ratio did not display any statistically significant relationships with bond yields. This study's recommendations underscored the importance of informed decision-making for investors, suggesting that investment in bonds might be advisable during periods of high inflation. For policymakers, prudent monetary policies were recommended to stabilize both interest rates and inflationary pressures. Financial analysts were encouraged to consider comprehensive macroeconomic factors before making predictions regarding bond yields. By heeding these recommendations, stakeholders could contribute to a more stable and prosperous bond market in Kenya, benefiting both the economy and individual investors.