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Bond Yields And Currencies

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Bond Yields and Currencies

Bonds are in comparison to currencies a lower yielding opportunities but are considered to be safer assets due to the fact that interest yields on the bond instruments are almost always fully guaranteed. For that reason, Institutions mostly buy bonds if there are some serious concerns in various markets. Which means that, bond-buying is associated with “risk-off” situation. Anytime “risk-off” is present in Global markets, the negative relationship between bond prices and bond yields starts to develop; the prices of bonds start to rise (Demand), which makes the yields to drop.

The safe-haven government bonds consist of The US Treasuries, The UK Gilts and the German Bund. In circumstances when Investors become overanxious about exactly where to put their funds, they simply park or should I say trust their money to safe governments with the understanding that they will receive their money back and also a yield. This is the same principle as buying safe currencies. There is a correlation between declining bond yields, representing increased demand for bonds and demand for safe currencies.

If there is a risk of dreadful Inflation, it creates a possibility of interest rate hikes; this in turn, directs to higher bond yields. Higher bond yields in most cases will lead to a future demand for the local currency. As we mentioned before, when foreign investors exchange their cash for the local currency in order to buy the bonds of that country, it will contribute to an increase in the valuation of the currency. This all leads to a conclusion that rising yield of the bond might result in a higher currency value in the future, if supported by a demand; subsequently, declining yields will lead to a currency depreciation.

We must clearly understand and differentiate the reasons for government bond demand. These include; bonds being perceived as safe haven instruments in times of turmoil, and/or interest rate increase expectation. The national currency and, in particular, its bond prices are inevitably linked with the country’s interest rate which in fact functions as the gauge for the bond yield. A common example of how a currency pertains to a bond could be the relationship (positive correlation) involving the US Dollar and the 10year Treasury Note.

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