Wednesday, 4 September 2013

2 Year bond yields

The importance of short term interest rates on the FX rates is undeniable and quite clear. Below is a YTD chart of the yield differential between the Us and German 2 Years vs. the EURUSD

EURUSD white, USDE2 spread Purple. Thomson Reuters

But we are at a very important point in the yields as we go into possibly the most important NFP of recent times. The consensus is a strong NFP (>175k) will be met with a guarantee of tapering in September as opposed to later on. 

But where does this put the Yield spread as this will have enormous influence on the FX rate, as we can see the US 2's broke above the two key levels approximately at 0.44%.

Us 2 year yield. Bloomberg

As we can see, there is definitely potential for the the yield to move higher, possibly to 0.5% and even higher.

But when we consider the Germans then it seems the ECB is the limiting factor for now

EUR EONIA 1Y1Y forwards. Bloomberg - H/T Nordea research.
As we can see by the EONIA forward, the ECB refi rate seems to be capping any further advances and this has a clear impact on the German 2 year yield as we can see below

German 2 year yield. Thomson Reuters

So what we can conclude is that from this is that we can see the German yields will struggle to move higher (although if tapering does occur I expect it to still break higher, just with more momentum).

And so if we get a much higher Us 2 yr yield ~0.6% by October is entirely possible. This, given recent correlation would imply a EUR/USD of approximately 1.2750.

As it stands I'll go into the "Septaper" event Long Schatz and short US 2's. As it stands now, the "price differential" on the futures is 0.3766. I am looking for a widening to 0.65 differential.

By buying FGBSc1 at 110.27 and shorting TUc1 at 109.89 (decimalized ofc) 

At the same one could consider hedging by buying EURUSD



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