The Bund is the German 10-Year Treasury bill, also known as a government bond. A holder of a bond is a creditor, and the issuer of a bond is called a borrower or debtor. When the price of the Bund increases, the yield received on that bond decreases and vice versa.
What is the relationship between Bund and EURUSD? Why is this relationship there?
The relationship between the Bund and EURUSD is inversely correlated - when the yield of the Bund increases, the Euro is bullish, and when it decreases it is bearish. One thing to note is that the price of a bond and the yield received is also inversely correlated.
The relationship is there because during periods of uncertainty, people generally look for less risky positions (they may liquidate any equity positions they may hold and invest in bonds if they have low confidence in the stock market). This new demand for bonds pushes the price higher, but forces the yields down. A quick equation can show why this occurs:
Let's say we have a bond priced at £1,000 with a 10% coupon rate (the amount you can expect to return per annum). The equation would be (£100/£1000) where yield = coupon value/price of bond. If the price of the bond increases to £2000, the yield decreases (£100/£2000) = 5% PA.
For a bond holder looking to sell the bond at a later date, this is good as they have already locked in the rate of interest that they will be paying. However, as a buyer of a bond, you want to be buying low to lock in a higher yield.
The factor that influences a bond more than any other is the level of prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, thereby lowering the yield of the older bonds and bringing them into line with newer bonds being issued with lower coupons.
Bond yields and FX
The spreads of the 10Y bonds can be used to gauge the direction for currencies as well. When the yield spread increases in favour of a certain currency, it is likely that you will see that currency appreciate vs others. When a yield spread tops or bottoms out, you can expect the related currency to begin to fall/rise in the following months. Playing on interest rate differentials is known as carry trading.
Above graph explained
The Bund is testing back to its 200 day EMA. On the recent occasions when it has tested here, it has failed to break above, however, the upward momentum appears to be intact .
In the short term there is clear divergence between Bund & EURUSD.
Furthermore our model shows the Bund as being a weakest bear suggesting it would like to go & turn bullish and indeed it would be back in a bull trend through 154 vs close last night of 152.9.
I am reading comments as I am still trying to understand the inter relationships. My understanding is that High Yields are not good for Governments going into a slow down and with Euro high against the Dollar isnt this damaging to the Euro companies with loans. ?
Why does rising periphery yields cause the Euro to fall. ? Is it because it makes the bond price higher . I am trying to understand which is the "horse" and which is the "cart" in the correlations.
Sorry for my poor understanding. ...
fxstraderomi
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yes Sir, situations is far from over
fxstraderomi
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Amid this Greek fiasco, every London morning, I was looking at German yields and periphery yields. Rising periphery yield and drop in German yield would bring in EUR shorts and vice versa.
Though Grexit uncertainty is down ...as believed by markets, Greek bond markets dont believe it I guess, as the Greek yield curve is still inverted !
DavidBelleFX
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I think it would be rational to assume that no one really wants to hold onto 30Y Greek bonds really haha. I think by the end of the year we will see some normality back, but this situation is far from over.
fxstraderomi
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true, it soes have strong correlation historically, especially after the ECB started making noise about the QE since mid 2014
DavidBelleFX
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Indeed. Pure capital flight.
fxstraderomi
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For last few days, I guess Bund yield and Euro/$ are largely uncorrelated. Rather EUR is largely behaving likely a funding currency. Falling probability of Grexit scenario pushed the EUR lower (USD higher as Fed moves one step closer to rate hike after Greek deal). and about the Monday's rise in EUR/$, it didnt track the US-German 10-year yield spread which widened slightly in favour of USD
DavidBelleFX
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You are 100% correct. The correlation has been pretty weak with this whole Greek fiasco, but historically it could be said that it has a pretty strong correlation.
Why does rising periphery yields cause the Euro to fall. ? Is it because it makes the bond price higher . I am trying to understand which is the "horse" and which is the "cart" in the correlations.
Sorry for my poor understanding. ...