FOREX AND GOVERNMENT BONDS
Forex traders should have an idea not only about currencies but also about other financial instruments. Futures, options, stocks, and bonds are closely linked to changes in exchange rates. In analytical reviews, one can often find references to the yield of government bonds of various countries. Interest rates in all economically developed countries are at a very low or zero level and practically do not affect currency fluctuations.
In such conditions, the role of government bond yield increased. The cost and yield of government bonds objectively reflect the state of the economy and finance. These securities are freely traded on exchanges, and the change in their indicators is interconnected with the international currency market. This is especially noticeable in the absence of other macroeconomic factors and news.
WHAT ARE BONDS
Any state has a budget, that is, income and expenses. All government activities require fixed costs, and the money for these costs comes from taxes and other sources. If at some point there are more expenses than incomes, then the financial authorities of the state borrow money. This is exactly the same loan that ordinary borrowers take from banks. Only public debt is executed in the form of securities – bonds.
Anyone can buy the bonds, and after the issue, they are freely traded in the market. The government pays a certain percentage on bonds. Typically, the volume of the bond issue is determined by the Ministry of Finance, and the treasury carries out the issue. The state guarantees the repurchase of bonds at par, so they are always in demand. Americans call these securities Treasury, and Europeans call Bond (bund).
BOND ISSUES AND MATURITIES
The issue of government bonds is designed to solve a number of problems. The main one is covering the budget deficit and short-term cash gaps. The state can raise funds to finance targeted projects, pay off other debts, and support social programs. The issue of bonds, as attracting money from private investors, is considered a better means than issuing money or borrowing from the Central Bank. In addition, government debt securities are used as a means of regulation in monetary policy.
Depending on the purpose of the bonds, they can be issued for various terms from several weeks to 30 years. Conventionally, they can be divided into three varieties – short-term up to three years, medium-term up to ten years and long-term over ten. The most common paper in the West – three-year and ten years. They affect the graphs of Forex and other tools. The methods for paying yield on bonds also vary. There are securities with a fixed income and floating.
CORRELATION OF GOVERNMENT BOND YIELDS AND FOREX MARKET
Before the 2008 crisis, the most important factors for major currencies were interest rates and the yield on two-year and three-year bonds. The greater the yield that could be obtained in a country, the greater the amount of money flowed into this country and its currency grew. In recent years, the effect of interest rates has declined, and ten-year bonds are more affected by exchange rates. The relationship between the dollar and the return on US safe assets, that is, ten-year treasuries, is especially strong.
Ten-year bonds reflect inflationary expectations. The main criterion is profitability, not cost. If profitability increases, then inflationary expectations rise. This information affects the actions of the Central Bank. Higher inflation causes higher rates and higher prices for currencies. With a fall in bond yields, the Central Bank will tighten its monetary policy, which will lead to a decrease in the national currency.
COMPARISON OF BOND YIELDS OF DIFFERENT COUNTRIES
If you compare the graph of the dollar index and 10-year Treasuries, then you can immediately see a strong correlation. However, currency pairs are traded on the Forex market, so it is important to compare the bond yields of the two countries. The simplest example is the euro and the dollar. German bonds have the greatest impact on the euro, so you should compare the movement charts of the yield of treasuries and bonds.
USE OF YIELD SPREAD IN FORECASTING
For any currency pair, you can analyze and compare the spread of government bond yields. This information is published on specialized sites. For a more accurate analysis, the spread can be calculated independently on online charts from TradingView. To do this, just open in one window two graphs of bond yields of two countries. You need to analyze not the value at the moment, but the dynamics of the spread. Although it is believed that bond yield analysis is only suitable for long-term trading, it can be used for any timeframe.
In the dynamics of profitability, there are also short-term trends, pullbacks, and corrections. You just have to watch a slightly higher timeframe than for a currency pair. So, for trading on the hourly chart, you should analyze the change in profitability for several days. For the daily chart, we analyze the changes in a few weeks. It should be borne in mind that the analysis of the bond yield spread is only one of the tools that work in conjunction with others.