Yield differentials: do you trade the spread between two yields?
The gap between two countries' bond yields tracks the relative attractiveness of their currencies, and some traders use it as a slow macro signal — entering when the differential turns and holding for weeks.
Do you?
- which yields you track for your pairs
- how a change in the differential becomes a trade
- the times the signal divorced from the currency
The bond yields guide explains the transmission.
Background: Bond yields and exchange rates: why currency traders watch the 2-year yield
Currencies often follow the gap between two countries' government bond yields. How yield differentials work, why 2-year yields track central bank expectations, and when the link breaks down.
Why do currency traders watch bond yields?
Because money tends to flow toward higher returns. The gap between two countries' bond yields, especially 2-year yields that track central bank expectations, often moves in line with their exchange rate.
What is a yield differential?
The difference between the yields on comparable government bonds in two countries, such as US and German 2-year bonds. A gap widening in one country's favour tends to support its currency.
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