US Bond Yields Drive the Market

Carry trades are still a ubiquitous feature of the forex market, but the driving force in the market today is not Japanese interest rates.  The ten-year US bond market has been the largest influence on international currencies.  The bond market has suffered recently, and the high yields have provided crucial support for the US dollar.  Especially with little US economic data on the docket for this week, currency traders are increasingly relying on yields to make their bets.

Yesterday, the US dollar gained ground against the Japanese yen, the euro and the Canadian dollar while losing ground against the New Zealand dollar, British pound and the Swiss franc.  The most interesting part of that scenario is that, with the exception of the Swiss franc, the dollar gained against every currency over which it had a yield advantage and lost against the currencies that had a yield advantage over it.  What we should ask ourselves is why US bond prices continue to fall?  Unfortunately, there is not a clear cut answer to that question.  But it might have something to do with the sub prime mortgage loan crisis in the United States, typified by the shutdown of two large hedge funds by Bear Sterns.

The effects of this on the currency market are startling.  While carry trades are in play, much of the momentum for the USD/JPY growth is certainly coming from high US yields.  With 10-year bond yields again reaching 5.15%, the forex market is simply shrugging off most other economic news.  Wednesday’s European economic data was actually pretty heartening.  PMI readings, especially in manufacturing, were better than expected, but the euro still fell against the dollar, as US yields determined the action.

The general situation repeated itself this morning.  The Federal Reserve Report for Philadelphia came out, and there were more first-timers on the unemployment rolls.  But the rest of the data was strong, with manufacturing picking up after a long layoff.  But the movement in the currency market was dollar-negative.  The US dollar lost most of its gains versus the Japanese yen and the Euro on the basis of falling bond yields.  The Germany IFO Business Climate Report is scheduled to be released at 4:00 PM today, and the data is likely to be positive.  But if recent forex activity has shown us anything, it’s that what happens to US 10-year bonds will matter more when it comes to currencies.