Yield spreads and why bond markets sometimes move first

[Shadow Trader]

Currency pairs reflect the relative attractiveness of two economies, and interest rate differentials are a core piece. Bond yields can respond to data and central bank comments a moment before FX does, because rates markets are very sensitive to rate expectations.

The most common example is USDJPY, which tracks the gap between US and Japanese government bond yields quite closely. When the US ten-year yield jumps, USDJPY often follows within seconds. The same relationship applies to EURUSD and the gap between German and US yields.

For a short-term trader, watching the two-year yield spread is often more informative than watching the ten-year. The two-year is more sensitive to near-term rate expectations, which is what moves currencies on a day-to-day basis.

The lag between yields and spot is small and shrinking. Retail traders cannot compete with automated systems on speed. But yields can still serve as a context filter. If USDJPY is rising and the yield spread is falling, caution is warranted.

Do you keep a yield chart open alongside your currency charts, and has it changed any of your trading decisions?