I’m struggling to get my head around something so could use some input.
I’m fairly new to understanding how bonds, yields, rates interact with currencies so please be gentle.
Let’s say I primarily trade the Cable and the bond spread between the two is relatively close.
BoE increases interest rates whilst the Fed keeps the U.S rate the same. Capital floods in to UK bonds due to the higher yield, the bond spread widens, demand for the pound surges and appreciates against the dollar. Cable therefore trades up.
How then, if UK bonds are skyrocketing because of their high coupon can the pound continue to appreciate against dollar when the heavy purchase of bonds = a lowering the yield?
It’s conflicting, right?
Or am I (more than likely) over thinking it?
@HappilyNorth
I think you are over thinking it. I see what you are trying to say (I think) but there is no perfect correlation between the purchase of gilts and the and a corresponding move in the Gbp
Also when you are referring to the spread you mean the spread of what?
Us bond vs uk bond yields ?
First up there are 2 bond markets so to speak. The UK gov decides they need some money so they issue some iou’s (UK call them gilts). Mr Moneybags buys them for 2 reasons, first the return (coupon) is better than current interest rates (maybe only slightly and Moneybags takes into account whether rates will remain the same, go up or down in the lifetime of the bond.
His second reason is risk - so things are looking bright up ahead - hmmm… think I’ll get a better return on stocks - they’ll have to really tempt me with this bond.
The second market is the ‘after market’ - Moneybags bought the bond and the return is fixed - meantime the outlook changed and he was wrong - economy in UK has jumped, inflation on the rise, BOE talking about rising rates - damn - Moneybags realizes he can get a better return elsewhere so he puts his bond up for sale.
Problem is all his mates are doing the same so the demand for these bonds are dropping- yet the coupon is fixed - but the price must come down, else he’ll never sell.
So the coupon (return/yield) remains the same yet the cost comes down.
Want to see it in real life? - check out DE10yr this past week - Mon flat, Tue smallish but determined push up (was watching this live) Wed more push up and more determined.
Thurs then the big push - guys went short the DAX Thursday morning.
Long post and I’ve generalized - maybe this link is better worded:
What Are Government Bonds | Learn About Bonds | IG UK.
Should have said most often the return on a bond is referred to as ‘Yield’ - thus as the price of a bond falls it’s yield (in percentage to cost) rises.
Also generally commentators mention the yield rather than price, but brokers will chart and quote price.
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Thanks John. Yes, yields of the 10y for each.
Thanks, Peter. That was very helpful. Appreciate the reply.
@HappilyNorth
Just as an aside bonds are going much higher, yields much lower.
The smart money is heavily positioned in the 30 year US bond right now
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