How bond yields affect currency markets?

What are Bonds?

Bonds are loans made to large organizations. These include corporations, cities, and national governments. An individual bond is a piece of a massive loan. That’s because the size of these entities requires them to borrow money from more than one source. Bonds are a type of fixed-income investment. The other types of investments are cash, stocks, commodities, and derivatives.

What are Bond Yields?

Bond yields are a measure of the profit you will make from your bond investment. The less you pay for a bond, the greater your profit will be and the higher your yield will be. Conversely, the more you pay for a bond, the smaller your profit will be and the lower your yield will be.

How it affects currency markets?

Bond yields differentials usually move along with currency pairs. This phenomenon occurs because capital flows are attracted to higher yielding currencies. As the rate of one currency increases relative to another, investors are attracted to the higher yielding currency. Additionally, the cost of owning the lower yielding currency increase as the bond yield differential moves in favor of the currency that is sold. For example, the cost to owning the Euro and selling the dollar will increase as US bond yields increase relative to European bond yields.

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