How Bond Spreads Between Two Countries Affect Their Exchange Rate?1 min read
The bond spread represents the difference between two countries’ bond yields. These differences give rise to carry trade.
As the bond spread between two economies widens, the currency of the country with the upper bond yield appreciates against the opposite currency of the country with the lower bond yield.
Once the recession of 2008 came along and every one the main central banks began to cut their interest rates, AUD/USD plunged from the .9000 handle backtrack to 0.7000.
One factor that’s probably live here is that traders are taking advantage of carry trades.
When bond spreads were increasing between the Aussie bonds and U.S. Treasuries, traders load on their long AUD/USD positions.
Once the Federal Reserve Bank of Australia started cutting rates and bond spreads began to tighten, traders reacted by unwinding their long AUD/USD positions, as they were not as profitable.
As the bond spread between the united kingdom bond and US bond decreased, the GBP/USD weakened also.