Educational Insight: Will The Dollar & US10Y Always Move Correlated?
There are times when the Dollar will move in tandem with US 10-year bond yields... but it’s not always the case....
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We have a great question from Flippo, who asks how can we have a medium downside bias for the Dollar but an upside bias on US 10-year bond yields?
Thanks for the great question Flippo. Now, when you drill down into the question it’s really based on a presupposition that the Dollar will always move correlated to US10Y bond yields, and secondly that yields is the most important driver for the Dollar.
Now, are there times when the Dollar will move in tandem with US 10-year bond yields? Yes definitely, but it’s not always the case.
Let’s take a quick look at a chart of the US 10-Year bond yield compared to the USD. Now if we just take a look at a few very recent cyclical examples, we’ll see that the assumption of a positive correlation doesn’t always hold true.
• From 2014 to 2015 where the US Dollar ripped to the upside while US10Y pushed lower considerably
• From the end of 2017 until Q2 of 2018 we had US10Y pushing higher while the Dollar was pushing lower
• From the end of 2018 until end of 2019 once again strong inverse move as yields plummeted while the Dollar was supported
• Now more recently from Sep 2020 until Feb 2021 we saw a strong inverse again
So, these examples show us that there are very recent examples that shows us that the correlation between a move in yields and it’s relevant currency isn’t always positive, and there is a few reasons for that.
1. Firstly, and a very important concept in the financial markets is that it’s never just one thing that’s driving a particular asset, there might be major themes in play for sure, but it’s never just one variable that influences price
2. So, to that point, is yield differentials an important driver for currencies? Absolutely, but it’s definitely not the only driver, there is also growth differentials, inflation differentials and purchasing power parity, there is terms of trade with current account and trade balance differences, there is fiscal policy, there is intermarket influences and then there is of course monetary policy
3. So, even though yields and yield differentials are important inputs for many FX value models, it’s just one part of a much bigger puzzle if that makes sense.
4. Secondly, when it comes to the US Dollar things are slightly more tricky compared to other currencies, because as the world’s reserve currency it’s sensitive to fluctuations in the global economy, in things like international trade.
5. What you will find is that during times when the global economy is doing really well, even if the US economy is doing well, as long as the global economy is doing well, especially during times of global synchronised growth, the Dollar usually does bad during times when the global economy is doing well or when we have reflation environments.
6. Then when the global economy is slowing down that usually sees the liquidity of Eurodollars slowing down which is usually a good environment for the US Dollar, and when I’m talking about Eurodollars in this context I don’t mean the EURUSD currency pair, the term Eurodollar refers to any Dollar in circulation outside the United States
For more detail - watch the video!
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If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
-----
We have a great question from Flippo, who asks how can we have a medium downside bias for the Dollar but an upside bias on US 10-year bond yields?
Thanks for the great question Flippo. Now, when you drill down into the question it’s really based on a presupposition that the Dollar will always move correlated to US10Y bond yields, and secondly that yields is the most important driver for the Dollar.
Now, are there times when the Dollar will move in tandem with US 10-year bond yields? Yes definitely, but it’s not always the case.
Let’s take a quick look at a chart of the US 10-Year bond yield compared to the USD. Now if we just take a look at a few very recent cyclical examples, we’ll see that the assumption of a positive correlation doesn’t always hold true.
• From 2014 to 2015 where the US Dollar ripped to the upside while US10Y pushed lower considerably
• From the end of 2017 until Q2 of 2018 we had US10Y pushing higher while the Dollar was pushing lower
• From the end of 2018 until end of 2019 once again strong inverse move as yields plummeted while the Dollar was supported
• Now more recently from Sep 2020 until Feb 2021 we saw a strong inverse again
So, these examples show us that there are very recent examples that shows us that the correlation between a move in yields and it’s relevant currency isn’t always positive, and there is a few reasons for that.
1. Firstly, and a very important concept in the financial markets is that it’s never just one thing that’s driving a particular asset, there might be major themes in play for sure, but it’s never just one variable that influences price
2. So, to that point, is yield differentials an important driver for currencies? Absolutely, but it’s definitely not the only driver, there is also growth differentials, inflation differentials and purchasing power parity, there is terms of trade with current account and trade balance differences, there is fiscal policy, there is intermarket influences and then there is of course monetary policy
3. So, even though yields and yield differentials are important inputs for many FX value models, it’s just one part of a much bigger puzzle if that makes sense.
4. Secondly, when it comes to the US Dollar things are slightly more tricky compared to other currencies, because as the world’s reserve currency it’s sensitive to fluctuations in the global economy, in things like international trade.
5. What you will find is that during times when the global economy is doing really well, even if the US economy is doing well, as long as the global economy is doing well, especially during times of global synchronised growth, the Dollar usually does bad during times when the global economy is doing well or when we have reflation environments.
6. Then when the global economy is slowing down that usually sees the liquidity of Eurodollars slowing down which is usually a good environment for the US Dollar, and when I’m talking about Eurodollars in this context I don’t mean the EURUSD currency pair, the term Eurodollar refers to any Dollar in circulation outside the United States
For more detail - watch the video!
-----
If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
