Bond is an “I love You” given out by an individual when it needs to borrow money.
These entities require lots of funds in order to operate so they frequently need to borrow from banks or individuals just like you. When you possess a government bond, basically, the government has loaned out money from you.
“Isn’t that the same as owning stocks?”
One main difference is that bonds usually have a distinct term to maturity, in which the proprietor gets paid back the money he lent, ( identified as the principal) at a prearranged set date. Similarly, when an investor buys a bond from a firm, he gets paid at a indicated rate of return, also branded as the bond yield, at definite time breaks. These periodical interest payments are usually known as coupon payments.
Bond yield speaks of to the rate of return or interest paid to the bondholder although the bond price is the sum of money the bondholder pays for the bond.
Bond prices and bond yields are inversely connected. When bond prices increase, bond yields drop and vice versa.
Always remember that inter market relationships rule currency price action.
In this instance, bond yields really help as an excellent pointer of the strength of a nation’s stock market, that increases demand of the nation’s currency.
Demand for bonds frequently upsurge when investors are worried about the protection of their stock investments. This flight to safety drives bond prices up and, by virtue of their inverse relationship, drives bond yields down.
As many investors stay away from stocks and other high risk investments, increased demand for “less-risky instruments” just like U.S. bonds and the safe-haven U.S. dollar drives their prices higher.
Another reason to keep in mind, government bond yields is that they perform as an pointer of the overall direction of the country’s interest percentage and expectations.
Let’s say, in the U.S., you would pay attention on the 10-year Treasury note. An increasing yield is dollar bullish. A declining yield is dollar bearish.
It is necessary to be aware about the underlying dynamic on why a bond’s yield is increasing or declining. It can be based on interest rate anticipations or it can be established on market indecision and a “flight to safety” to less risky bonds.
After knowing how rising bond yields generally cause a country’s currency to increase in value, you probably want to know how this can be useful to forex trading.
Remember that one of our objective in currency trading, apart from gathering plenty of pips, is to put together a strong currency with a weak one by first linking their respective markets.