Bond Spreads In Forex

Bond Spreads in Forex Trading

Came across a really interesting article by Kathy Lien, Chief Strategist at FXCM about Bond Spreads and Interest and how they affect the Forex Market. Some of this is common sense, but is always good to be reiterated and gone over from time to time. Including the idea that investors will tend to seek higher yields on interest rates and thusly buy currencies with higher rates than the currency they are holding.

Kathy used the example of US offering interest rates of 2% and Australia offering interest rates of 5%. For large institutions, the real market movers, this could mean thousands of dollars in interest alone every day on top of what they make on exchange rate. So this is one reason why this is so important to look after these interest rate levels for foreign currencies. This of course gives way to the popularity of the carry trade. Thusly, she attributes the popularity of pairs like AUD/JPY, AUD/USD, NZD/USD, USD/CAD to this carry trade method of trading Forex.¹

The term “bond spreads” or “spreads” refers to the interest rate differential between two bonds. Mathematically, a bond spread is the simple subtraction of one bond yield from another.²

I won’t go into much more detail, the original poster makes a great case how to take advantage of these differences in interest rate yields. Technically, using this method is determined to be a leading indicator, but on a long term time frame, aside from catching news announcements I don’t see how this could be traded on an interday level. Read Kathy’s article at

http://www.investopedia.com/articles/forex/05/041305.asp

1. Bond Spreads: A Leading Indicator For Forex by Kathy Lien, http://www.investopedia.com/articles/forex/05/041305.asp [↩]
2. http://www.finpipe.com/spread.htm [↩]