Did some reading on bonds, yields, prices and SMT and this is what I found out:
ICT says it all starts with bond yields. Bonds are a leading indicator because the market will gravitate to the greater ROI. A central bank auctions off bonds to the lowest bidder, that is the lowest yield bidder. Bankers and the bond auctioneer sit in a room and the bond auctioneer starts the bid at whatever price they think will get the ball rolling, say 5%. The bankers say “I have $10 mill and I’m willing to accept a lower yield than your initial offering, say 4%”. The next guy says “I have $20 mill and I will accept 3% return.” The $5 million and smaller guys don’t need to bid and won’t affect yields so it is only the really big fish who are moving yields around.
At some point the yield becomes so low that it is unattractive to the deep pockets for that auction session and they will wait until the next auction. This is how bond yields fall and find a lower level, a true free market pressure environment. If those with money think they can get a better yield in the market and the market is safe enough, they are less willing to bid lower on the bonds. This is how yields go up. That is, a central bank still [U]needs[/U] to issue bonds but has to raise yields to entice them to park money in bonds. So if risk is off (they are afraid of a risky market), yields drop because bonds are more attractive than the market and the big players are pushing yields down in competition with each other. If risk is on, yields go up because the auctioneer has to compete with a risky but very (hopefully) profitable market for return.
For forex traders, if yields are down (risk off) not only are they buying bonds (pretty safe already) they are buying US bonds (really, really safe). This means if the market is already unsafe, and yields are dropping, USD gets stronger because it is in demand as the safe haven. Buying a bond with a 0.1% return is way safer than having it in stocks that are taking a 5% loss. A 0.1% return actually beats the market by 5.1%. Getting a US bond at 0.1% return is safer than getting a Greek bond at 0.2% and the yield isn’t high enough on the Greek debt to make the risk worth it. If the yields were 0.5%, it might be worth it. This is why even if a foreign currency yield is higher than USD but all bond yields are falling, the USD still is the bond of choice because it is safer. So yields rising will put up pressure on foreign currencies in relation to the dollar. Lower yields puts up pressure on USD, the safe haven.
“Bond prices” are made on the futures market has nothing to do with the central banks and doesn’t influence us as forex traders. Imagine a high yield bond is worth 5$ over the course of its 5 year term. 1 year later bond yields drop. If you have a high yield bond that you bought last year and I don’t like the current yield, and I really want to park my money in bonds, I might go to you and offer you $1 for your bond. You earned $1 already on it because you have had it for a year, and I will give you $1 more and this effectively doubles you ROI for the year. Since I don’t think bond prices are going back up soon, I still think the remaining $3 is a good investment for me. So as NEW bond yields drop, the OLD bonds with higher yields become more valuable in the futures market and prices go up for them. If NEW bond yields are rising, demand for the OLD lower yields bonds goes down and bond prices fall.
We are concerned with yield only, not price, unless we were in the futures market. ICT doesn’t look at bond prices at all, only yields. We watch for SMT divergence in HH and HL or LH and LL. A divergence means big money had run the yields rates somewhere and this will exert a pressure on all currencies. SMT divergence with bonds doesn’t need to be at any support or resistance. [U]SMT divergence on any other chart is needs to be at a S/R level or it is meaningless.[/U]
Bond yields up = risk on = foreign currencies up
Bond yields down = risk off = USD up
Check the 2y GBP, USD and EUR(German) to look for divergences. Also the 5y and 10y. Check every week when doing higher TF analysis and compare with seasonal tendencies. We are looking for a SMT divergence to signal a possible change in trend. If we see an SMT divergence we don’t automatically buy or sell, we wait for buy and sell signals, S/R, and SMT divergence on the correlated pairs to get us in. It influences our directional bias and tells us we’re likely to see a major trend reversal.
BTW - SMT divergence is a trend breaking indicator. If we are trending up which by definition means HH and HL, SMT divergence will show a failure to make a HH or will make a LL on one of the correlated pairs or bonds, breaking market structure. This is a strong indication the T-rex is trying to sneak into the pool one limb at a time. We would look for sell signals on the lower TF’s at a significant S/R, while all the trend followers are about to be caught on the wrong side of the market.
Bond auction source:
Institutional - How Treasury Auctions Work
Paste the following into this chart to look for triad divergences:
US Generic Govt 10 Year Yield Chart - USGG10YR - Bloomberg
USGG10YR:IND
GUKG10:IND
GDBR10:IND
USGG5YR:IND
GUKG5:IND
GDBR5:IND
USGG2YR:IND
GUKG2:IND
GDBR2:IND
DAX:IND (German Stock Index)
INDU:IND (DowJones Industrial Averave Index)
NKY:IND (Nikkei)
