Applying Bonds to FX
How sovereign yields move currencies — the real mechanism
- Explain the rate-differential mechanism currency-by-currency
- Identify which tenor matters most for each currency pair
- Spot when bonds and FX disagree (and which to trust)
The 2y US Treasury yield moves 5bp. EUR/USD drops 30 pips within minutes. There's no Fed decision, no CPI, no headline — just bonds telling FX what the rate path looks like. The cleanest signal in macro lives in this connection.
The mechanism in detail
When US yields rise, US-denominated assets become more attractive to foreign investors. They convert their currency to USD, push USD up against everything else. The cleanest tenor is 2-year: it captures the next 24 months of expected Fed policy. The 10-year captures longer expectations + term premium.
EUR/USD tracks the gap between US 2y and German 2y (Bund). When US 2y rises relative to Bund, EUR/USD falls. The math: where do investors get paid more in the next 2 years?
USD/JPY has historically tracked US 10y minus JGB 10y. Long-duration sensitivity because BoJ controlled the short end with yield curve control. Now (post-YCC), 2y matters more too.
When bonds and FX disagree
Bonds lead FX 80% of the time. When they disagree — bonds move but FX doesn't, or vice versa — trust the bonds. FX often has 'sticky' positioning that lags by hours/days. The classic trade: spot a bond move that FX hasn't priced yet, position for FX to catch up.
US 2y yield up 12bp in one session; Bund 2y unchanged. EUR/USD didn't move. Best read?
- Yields drive FX through capital flows
- 2y differential = best for EUR/USD; 10y for traditional USD/JPY
- Bonds lead FX 80% of the time
- When they disagree, position for FX to catch up to bonds
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