Economists have been noting with some concern a global trend of rising long-term bond yields. Interest rates are one of the key drivers for currency movements, so it’s something forex traders should take note of. Long-term yields function differently from short-term ones as far as the forex impact is concerned. Given the global context, these changes could be an important factor in how currency pairs move in the coming weeks or months.
Typically, long-term yields are related to the market’s perception of fiscal stability. A series of political events around the world has left traders concerned about the geopolitical situation. Aside from generally supporting safe-haven flows, bolstering gold and the dollar, yields could move individual currencies. Particularly when the inciting incidents include several of the currency majors.
What’s Driving Global Long-Term Yields?
The more dramatic events include mass protests in Indonesia and the burning of the parliament building in Nepal. But major developed countries have not been immune. Last weekend, Japan’s Prime Minister resigned, a day before France’s Prime Minister lost a no-confidence vote. The US is once again facing the prospect of a government shutdown as Congress struggles to pass spending legislation. The UK has had two cabinet reshuffles this month alone as the government struggles to prepare its budget.
The common theme in all of these events is high debt and spending levels. Japan has the highest debt-to-GDP ratio in the world, and the government is increasingly unpopular amid rising inflation. The size of the debt makes it difficult for the BOJ to take measures to fight inflation, as raising rates would significantly increase interest rate payments by the government. France’s government fell after the Prime Minister was unable to secure €44 billion in spending cuts to bring its finances back in line.
How Yields Affect the Markets
When government debt rises too high, markets begin to worry that the government won’t be able to pay it back. There are basically two ways to deal with excess debt: Default or inflation. In either scenario, investors lose money they have loaned to the government in the form of bonds. To compensate for that risk, they demand higher interest rates on long-term bonds. This is the rise in long-term yields being seen around the world.
Normally, Forex traders are tracking short-term (under 2-year) yields as they respond to central bank interest rates. This is part of the normal market fluctuations as investors look for the highest interest rates for their capital. With higher interest rates, the currency typically becomes stronger.
Why It’s Different This Time
But with long-term rates, the effect is the opposite. Higher yields mean that investors are worried bout the economic stability of the country, whether that’s growth, inflation or fiscal policy. They will be less likely to invest in assets denominated in that currency, which weakens it.
If global yield rises in tandem, then there is no comparative advantage, so the effect is minimised. But yields don’t rise by the same amount in every country. UK gilt yields, for example, are at 30-year highs, while Euroarea yields are still lower than they were a couple of years ago. The variance in long-term yields adds a new dimension to which currencies rise and fall, which could be a bigger factor as long as the current political climate persists.
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