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What Bond Yields Tell Us About The Forex Market

There are two kinds of bond yields: 1.Actual Yield This is the amount of interest a bond holder (who bought the bond in the primary market when it was originally being issued) will be paid after the lifespan of the bond expires (assuming he doesn't sell the bond prematurely) 2.Yield To Maturity (YTM) This is the amount of interest a bond holder (who bought the bond in the secondary market meaning he bought the bond as second hand from someone else) will get when the lifespan of the bond is reached. The YTM is the one forex traders should be more concerned with. Whenever a bondholder is afraid that the bond issuer (which is the government) is going to increase interest rates, the bondholder could decide to sell the bond so he can use the money to buy new bonds at a higher interest rate. if he wants to sell the bonds to you, the yield you will be getting is YTM not actual yield because the original bondholder would have already enjoyed some parts of the yield payment. if he sells the bond to you at the original price he bought it at, he will be cheating you because he has already enjoyed part of the yield payment so you will get a bad deal. To solve this problem and allow equity to reign, the original bond holder must reduce the selling price and sell to you at a lower price so you get a higher YTM. So as a trader when you hear that bond yields have gone up, most times they are referring to YTM and it means there is fear of interest rate hikes so bond holders are getting rid of old bonds and hoping to buy new bonds when the interest rate is hiked. And remember that interest rates are the number one influencer of exchange rate of currencies, a higher interest rate will make a currency appreciate (this works for healthy economies only). So if the news says US bond yields are at a 30 year high, it could mean investors expect the Federal Reserve Bank to hike interest rates so the US Dollar could be expected to appreciate and EUR/USD price will fall But if the news says US bond yields are falling, it could mean an interest rate cut is expected so investors/bondholders will not want to sell their bonds for cheap and investors could decide to sell the dollar and move to equities and fixed income meaning the price of a major pair like EUR/USD will rise.

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