How Fixed Income Securities Affect Currency Movements

A quick recap: So far, we’ve discussed how differences in rates of return can serve as an indicator of currency price movement.

As the bond spread or interest rate differential between two economies increases, the currency with the higher bond yield or interest rate generally appreciates against the other.

Fixed income securities (including bonds) are investments that offer a fixed payment at regular time intervals.

Economies that offer higher returns on their fixed income securities should attract more investments.

This would then make their local currency more attractive than those of other economies offering lower returns on their fixed income market.

For instance, let’s consider gilts and Euribors (we’re talking about U.K. bonds and European securities here!).If Euribors are offering a lower rate of return compared to gilts, investors would be discouraged from putting their money in the eurozone’s fixed income market and would rather place their money in higher-yielding assets.

Because of that, the EUR could weaken against other currencies, particularly the GBP.

This phenomenon applies to virtually any fixed income market and for any currency.

You can compare the yields on the fixed income securities of Brazil to the fixed income market of Russia and use the differentials to predict the behavior of the real and the ruble.

Or you can look at the fixed income yields of Irish securities in comparison to those in Korea… Well, you get the picture.

If you want to try your hand at these correlations, data on government and corporate bonds can be found on these two websites:

• Bloomberg
• Trading Economics

You can also check out the government website of a particular country to find out the current bond yields. Those are usually pretty accurate. They are the government.

In fact, most countries offer bonds but you might want to stick to those whose currencies are part of the majors.

Here are some of the popular bonds from around the globe and their cool nicknames:

Some countries also offer bonds with varying terms to maturity so just make sure you are comparing bonds with the same term to maturity (such as 5-year gilts to 5-year Euribors), otherwise, your analysis would be off.

And we wouldn’t want that, would we?

Reprinted from Babypips, the copyright all reserved by the original author.