FX Strategists at UOB Group assessed the correlation between yield spreads and FX.

Key Quotes

“Yield spreads or rate differentials are one of many indicators offering an insight into currency movements. In simple terms, currency pairs tend to correlate better with changes in yield spreads”.

“However, due to the presence of other dominant drivers, currency pairs may not necessarily move in line with yield spreads. Some examples include anticipated changes in monetary policy, changes in underlying trade patterns, investor flows or basic balances”.

“This strategy note covers a brief discussion of four key pairs of yield spreads that have caught investor attention recently”.

“Both USD/JPY and AUD/USD appear to have dislocated from their underlying 10 year yield spread”.

“The JPY has recently strengthened despite yield spread moving in flavor of the USD. This further strength in the JPY may signal increasing market skepticism over the BoJ’s commitment to maintain yield curve control”.

“The AUD has not weakened as much despite yield spread moving against it. Strong bulk commodity prices may have helped to buffer the AUD against this deterioration in yield spread”.

“On the other hand, USD/HKD trades very well in line with the widening spread between 3M US Libor and 3M HK Hibor rates. Spot has now risen to 7.83, as this 3M spread widened to 95 bps. The HKMA may well need to issue additional bills to ensure that Hibor rates do not fall too far behind the strong rise in US libor rates”.

“Finally, the recent tentative consolidation in 10s2s US Treasuries yield spread has offered some respite to the USD. As the 10s2s US Treasuries yield spread stabilized above 50 bps over the past month, the DXY Index was able to hang onto the 88 to 90 trading range. However, most would agree that it is still premature to call for a sustained rebound in the USD”.