For a forex trader, it may not seem like it can get any more boring than investing in bonds. In a bull market, the returns seem very scant in comparison to the returns that can easily be achieved in currencies. However, in a bear market, bonds begin to receive more attention, because of their stability as a government backed security.
This article is not really about investing in bonds. However, people who trade the foreign exchange market will want to consider the subject of this article.
Can watching the bond market somehow give you an indication of whether a currency will make a trend reversal or continue the way it was? Is there a way to know what a currency will do in the near future based on what is happening now in the bond market? The new trader may wonder whether or not there is a relationship between bond performance and currency performance, and whether or not such a relationship can be exploited to find new trading opportunities.
To answer this, we need to understand why we’re interested in bonds in the first place. Government bonds are securities used to fund the government’s debt. These bonds are never in danger of default since the government has the legal right to print money. So, obviously, this is one of the safest investments one can make as there is virtually no risk. Wouldn’t it be nice if, whenever we had a debt to pay, we could simply print up some more money and give it to the owed? Also, the government follows through and pays these bonds off on schedule (once again, it’s not too big a problem for the government to cover these bills), so other investment tools’ performances tend to be compared directly to that of the government bond, as a sort of standard benchmark. Most importantly, these bonds are used to fund government spending. So, when the bond market fluctuates, it is an indication of change within the government, its policies, its budgets, and so on. Erratic fluctuations may indicate instability, or the beginnings of strong trend move.
These erratic or dramatic fluctuations provide confidence levels in governmental policies and strength levels of its deficit. This obviously impacts the value of the government’s currency. The term-yield structure of the governmental bond market provides signals for a currency’s movement, since it, like the forex, is dependent on inflation, which is related to growth.
A discerning trader can keep his eyes on the bond market to have an idea of the direction the currency pair he is watching will travel, whether it will continue its current trend or begin a trend reversal. The currency feels the impact of any bond market fluctuation as the market reacts to the bond market and is reflected by the fluctuation of currency prices throughout the trading day.
Even though there is a relationship between the bond market and the foreign exchange’s performance, these two markets will take turns sometimes in leading the markets in reacting to changes in interest rate expectations. (As interest rates rise, bond prices fall.) Sometimes the forex market will lead the way with its reaction, while other times, the bond market will react first. There is no real way to identify which market will react first. The bond market’s effects on the forex are not only felt in smaller time frames, but tend to also effect more major forex trends. Because of the nature of the movement, the relationship between bond and currency should probably be considered to factor in on longer-term trades.
So, in conclusion, yes, the bond market does affect currency behavior. But before you go looking for some bond-currency EA to load into your forex software, while there are some relationships, this should by no means be considered a Holy Grail for forex trading. In fact, for the average trader, the relationship between the two markets will serve more as a novelty and something to observe when looking backwards at charts, rather than trying to somehow exploit this relationship. The behavior is sometimes a little unpredictable or seemingly detached in real time. Sometimes, the bond market will lead in reaction to interest rate changes, while other times, it will be the currencies that react first. In real time, it may be hard to determine the amount of lag, so discernment is encouraged in trading on any bond-related fundamental strategy.
This article was written by Forex day trader, Thomas Grow. Thomas is the creator of the high-yielding “Fat Ninja FX” trading system, and a staff writer for ForexFraud.com.