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Chapter 28, Part II. Relation with Other Financial Markets. Page 7

Discussion in 'Complete Trading Education- Forex Military School' started by Sive Morten, Dec 26, 2013.

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  1. Sive Morten

    Sive Morten Special Consultant to the FPA

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    BOND SPREADS

    Commander in Pips: I just want to give you small add-on to the bonds topic. First what spread is. Spread is just a difference between yields to maturity (YTM). Spreads could be inter-market or intra-market. Intermarket spread is the one that calculates spread between bonds of different countries but equal maturity. For instance 10-year US Treasuries YTM and 10-year Australian Government note. This kind of spreads has a close relationship to carry trade that we’ve discussed in the corresponding chapter. In fact, this spread shows the value of this carry trade in time, since rates are subject to change since they are traded on an open market.

    If you draw on the chart spread between 2-year US Treasuries notes and 2-year Australian notes – you will find that it closely repeats the chart of the AUD/USD, since as spread rises – the cost of carry also rises and that is linked with appreciation of the AUD. When suddenly rates have been decreased by the Australian Central Bank and Fed Reserve – spread has tighten significantly, cost of carry reduced and this has led to closing of AUD positions and decreasing of the AUD/USD.

    The second type of spread is intra-market. This is the spread that calculates between bonds of the same country but with different maturities. For instance, the spread between 10-year US Treasuries note and 2-year notes. Since short-term rates are tightly linked with the Fed rate – they react faster on Fed policy. This spread widens during recession period and tightens during growth.

    Here is the chart of 2-year Treasury note and Fed Fund Rate:


    Chart #2 | 2-year US Treasuries note and Fed Fund rate
    [​IMG]

    You can see, that 2-year note reacts on rate increasing/decreasing moments a bit in advance of Fed. That happens because market already feels the moment is coming and starts to price-in this event. Here is the chart of US Dollar index and 6-month to 10-year yield ratio.
     
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