How bond yields influence forex market?
Let’s talk about so-called “I owe you” documents – bonds. Imagine, an entity (such as governments, municipalities) needs a whaling sum of money in order to cover its growing expenses so it decides to borrow some from commercial banks or even individuals like you. If you lend some money to these unfortunate entities, they will give you a bond in return (it serves as a black spot for them, an ominous reminder of their debt). In a predetermined term, an official entity will have to pay it back with a certain yield. Bond yield can also be referred as an interest paid to the bondholder.
There is a negative relation between bonds prices and bond yields. When bond prices rise, bond yields fall and the other way round.
Now, you’re probably itching to find out what does this all has to do with the forex market? Arm with patience, we are reaching the point.
Bond yields actually is an excellent indicator of the strength of a nation’s stock market, which increases demand of the nation’s currency. The US bond yields reflect on the performance of the US stock market, thereby influencing the demand for the American currency.
During market distress periods, people usually tend to shift their assets from their stock investments to more secure ones (commonly known as safe havens) – the US government bonds, for example. This search for safety drives the US bond prices higher and the US dollar appreciates, whereas the bond yields depreciate. A rising yield is known to be a dollar bullish, and a falling yield is a well-known dollar bearish. And here you have it, this relationship between the yield of the bonds, and the general trend of the currency.