Dissecting Eur-Usd-Bonds correlation could be quite a challenging task.
This correlation analysis can run deep so sit tight and chill out while I attempt to serve you full platter on this topic.
A bond is a debt security.
The issuer of the bond is called debtor or borrower. The holder of the bond is the lender or creditor. The issuer of the bond in a contract promises to pay the bond holder interest or coupon and/or to repay the principal at a later date, termed maturity.
Of all the available different kinds of bonds, for our discussion I will primarily focus on the U.S. government debt security, also known as Treasury Bonds or T-bonds. The U.S. bonds are traded through the Chicago Board of Trade (CBOT).
Bonds and stocks are both securities, but the primary difference between the two is that bond holders are treated as lenders whereas stockholders are considered as the owners.
Another difference is that bonds usually have a defined maturity period whereas stocks may be outstanding indefinitely.
The yield on a bond shows the rate of return investors will reap. The price of the bond is determined on the open market.
The yield and price share inverse relationship, i.e. when price rises yields fall and vice versa.
Allow me to penetrate deeper into yields and price confusion in bonds.
If you buy bonds with a 10% coupon at its $100 par value, the yield is 10% ($100/$1000). However, if the price goes down to $80, then the yield goes up to 12.5%.
This price-yield fluctuation offers bond holder the same guaranteed $100 on an asset that is worth $800 ($100/$800).
Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200).
It's imperative to know that high yields and high prices both can't simply occur at the same time.
So if I want to buy bonds, do I seek higher yields or higher prices? The answer depends on investor's point of view.
If I'm a bond buyer, I want high yields. Say, I want to pay $800 for the $1,000 bond, which gives the bond a high yield of 12.5%.
On the other hand, if I already own a bond, I've locked in my interest rate, so only thing that I can expect is that the price of the bond goes up. This way I can cash out by selling my bond in the future.
Of the most prevalent the U.S. 2-year, 10-year, and 30-year bonds, I will focus most of my attention to the U.S. 10-year bond. The following strong Eur-Usd-Bonds correlation is noteworthy about the U.S. 10-year bond.
If the yield of the 10-year bond rises, the EUR/USD will drop and vice-versa. To shed more light into the mechanism of Eur-Usd-Bonds correlation, let's explore into equities correlation to bonds.
When economic chaos rules in equity market, investors get frenzy and nervous due to unforeseen uncertainties.
The classic moves investors make in such scenario is to liquidate their stocks in publicly traded corporations to move to safer haven such as bonds and gold.
This shift of liquidity from stocks to bonds make the stock market drop which results in the yields on bonds drop.
So enlightened with this equities correlation to bonds gunsligner investors should be contemplating following -
...I see economic issues in the U.S. economy...the yields on bonds are winding down hence other investors are buying up securities...may be the Fed will be cutting interest rates...I'd better start selling U.S Dollars and buying Euros.
Or,..Wow, I see bond yields are soaring, looks like the Fed is probably going to raise interest rates...I'll better load tons of U.S. Dollar and dump my Euro longs...
Keep this concept simple - the investment dollar flows where the interest rate yields are greater and best.
Soaring bond yields could send signal to the enlightened investors that the Fed is likely to increase interest rates in near future.
Similarly, drop in bond yields could alarm investors that the Fed might likely cut interest rates sooner than later.
These fundamental news on Eur-Usd-Bonds correlation can add great insights into the near future direction that Eur-Usd will likely shape into.
This is the reason Eur-Usd-Bonds correlation serves as a leading forex market indicator. So if you understand this market sentiment, you'll be far ahead in scoring the points.