Government Bond Yields

Currency markets follow the fixed income market. Yields process the same information first and more precisely, so watching only spot FX means reading the last chapter of a story published elsewhere.

Two ends of the curve, two messages

The two-year point is close to a pure expression of what the market expects the central bank to do, and it is the single most useful macro input for an exchange rate. The ten-year point mixes growth expectations, inflation expectations and a term premium for uncertainty, so it responds to fiscal news and risk appetite as well as to policy.

What to watch for

Currency direction follows the spread between two countries, not the absolute level in either. And the combination worth treating as a warning is a country’s long-end yields rising sharply while its currency falls: under normal conditions higher yields support a currency, so when both move the wrong way together the market is demanding more compensation to hold that country’s assets at the same time as it reduces exposure.

Further reading: Bond yields are the FX market’s nervous system.