Whilst reading through the articles on forexlive and bloomberg etc I always come across news on bond and treasury yields for 5, 10 or 20 yrs etc. Also there is always some country issuing bonds. Could you place give your take on and talk a little about how these impact on currency trading.
Also we always have news on crude, gold and stock markets. Could you also please briefly cover the interaction of these markets with the currency market.
I will offer you my take on the bond/treasury yields and what their impact can be.
Bond Yields and Corporations
Each countries bond yields can be an important component in helping to forecast where an economy can be headed. They can help in anticipating what could happen in the future. Yields move inversely with bond prices. So if you are looking at a chart of the US bond futures, as the price of the bond prices, the yield falls. If the price of the bond falls, then the yield rises.
The bond yields of the a country are important because they set a benchmark from which corporations issue debt. When a corporation issues debt, they will typically have to sell it a premium to whatever the prevailing rate is for the countries bonds. So lets say the U.S. 10 year bond yield is at 3.00%, when a corporation issues 10 year debt, they will have to accept an interest rate higher than 3.00%, because a corporation is deemed a bit riskier than the US Treasury, so the corporation has to pay a higher interest rate. So part of the interest rate a corporation pays, will depend on what the current yield is for the government debt, and also what credit rating they have. So lets say a company is rating AAA, the highest, they may pay 4.00% for their 10 year bond, a spread of 1.00% over the 10 year US treasuries. If the corporation had a lower credit rating (higher risk of default), then they would have pay even more interest.
A corporation wants to pay the least interest possible. Lower interest costs means debt is cheap to fund and they can use that money to fund an expansion of their company, more factories, more workers, maybe even buyback some of their own stock if they think it is undervalued.
So when the Federal Reserve lowers interest rates, and/or does QE, they are attempting to cause people to buy bonds, pushing the yield lower, to eventually make it cheaper and more attractive for companies and individuals to take on debt to grow the economy, etc.
I don’t pay nearly as much attention on all the different bond spreads, etc with regards to forex trading. There are some traders and hedge funds out there that trade the spread relationships between various bonds and their maturity dates. I don’t do that as I am a much more directional trader.
Bond Yields In Currencies
So how do the bond yields work in forex? Well I can give you some recent examples to see how they would work. Always bearing in mind that my primary focus is on the global macro scenario. So whenever I am interpreting bond yields, etc I am always asking about what is the impact on monetary policy and economic growth (which effects monetary policy), etc.
One example would be the rise in USD/JPY. One could argue that the large rise in USD/JPY over the past 15 months was due to Japan engaging in QE, raising their inflation target etc, as well some stronger U.S. economic growth. That would be the standard global macro scenario reason. Now, if someone wanted to dig deeper, they could try to find reasons in the US -Japanese bond spreads. One could say that the yield between 10 yr US debt and 10 yr Japan debt has widened by 100 basis points or more (1.00% +). So one could say that Japanese yields have been low over the past year, while US yields have risen to take into account the tapering of QE and stronger economic growth. So US debt yields around 3.00%, while 10 yr Japan debt yields only 0.75%. So there could be some Japanese money that comes in and sells JPY and buys USD, so they can go buy the higher yielding US debt. And that contributed to USD/JPY going higher. That would be the more elaborated answer.
Personally, I usually don’t go into that deep analysis, but it is possible I may branch into it sometime in the future. I just focus on the macro catalysts listed in the scenario sheets above with the news impacts and information flow – how fast Fed will taper, Will Japan do more QE, is U.S. economic growth going to accelerate or weaken, etc.
That would be for yield spread analysis between countries.
I do like to look at what the bond prices and yields are because they influence economic growth. If bond price go down, that causes yields to rise, which can lead to tighter financial conditions (sort of like a Fed rate hike), which can lead to higher mortgage costs, higher corporate debt costs, etc which slows down the recovery.
I pay attention to them because for example if I see that bond prices are dropping a lot, then I may be able to draw conclusions on that impact to monetary policy and other markets. I may say: “yields are rising a lot, this may slow down the economy and cause the S&P and equities to drop.” Or I may say, “the Fed may get worried that yields are rising so much, so they may delay tapering, etc.” If they delay taper, then perhaps the USD can get hit. Those could be some scenarios and examples.
Currently, bonds are bouncing off their lows, and keeping yields relatively low, so the economic growth looks like it will stay on track for the current moment. Relatively low bond yields, and relatively low crude oil prices (below $100) are helping to boost the economy.
Relationships Between Markets
So anytime I am analyzing crude, gold, stock markets, etc, I would ask the questions: Why is the individual market moving? Is there a catalyst specific to that individual market that is causing the market to move? I first try to identify the scenarios and forces individual to each market. If I can’t identify that, then I try to find what catalyst are causing multiple markets to move (more risk appetite / risk aversion). Always keeping in the back of my mind that I am looking for what the impact would be on the economy and the impact, if any on monetary policy.
Like in the examples given above, if I see bond prices rallying a lot, yields would go lower, and that would generally help the recovery. However, I would also have to analyze why bond prices are rising. If they are rising to due safe haven bid from some risk aversion event, then it is possible the economy might suffer if the negative impact to growth from the risk aversion event, is greater than the boost to growth from the lower interest rates.
If I see bond prices dropping a lot, then that could slow the economy. I would ask why are bonds dropping? Are they dropping due to Fed taper? A Fed rate hike? Inflation concerns?
If I see Crude oil rising a lot, then I would ask is that going to slow the economy? Is that going to push up inflation to a level that would worry the Fed?
If I see Crude dropping a lot, then I would ask is that going to boost the economy (through more money for consumers to spend, less shipping/transportation costs, etc)?
To the extent that the bond market, crude, gold, stock markets influence forex, I would have to first figure out the reason why the market moved in the first place. If the reason is global macro related, and influences some sort of economic growth or Federal Reserve policy, then it can a foreign exchange impact.