Intermarket analysis is an often neglected and overlooked type of analysis among traders. However, it's a powerful tool that can help you anticipate future price movements by following the performance of other, closely-related markets.
Intermarket analysis refers to the analysis of other asset classes that can provide valuable and actionable insights into related markets, such as forex.
In this part of our Intermarket analysis lesson, we'll be focusing on a specific asset class that has a very close connection with currencies: the sovereign bond market and yields.
As you already know from my previous educational posts, currencies tend to follow interest rates. With the fall of the Bretton Woods agreement, currencies became freely-floating and capital started to move to places with the highest yields, which meant higher returns for investors.
For example, if Australia has a 3% interest rate and Japan a 1% interest rate, investors could buy AUD to collect a 3% rate and short JPY by paying a 1% rate, leaving them with a net profit of 2%. This is how carry trade work, and the long AUD/JPY was one of the most popular carry trades given the large yield differential between Australia and Japan.
That's why you need to follow yield differentials in your trading. The chart above shows the EUR/USD pair, and the 2-year yield differentials between 2-year German bonds and 2-year US bonds. Notice that we're using German bonds (also known as "bunds"), since Germany is the largest European economy.
To add yield differentials to your chart, simply hit the "+" (compare) above your chart and type in "DE02Y - US02Y" with a space between the symbols. This also works for other currencies. Here is a list of symbols for the major currencies and their respective bond yields: US02Y, CA02Y, GB02Y, DE02Y, JP02Y, AU02Y, and NZ02Y. The currency should be self-explanatory from the symbols (note, we also the German 2-year yield when analyzing CHF.)
Notice how the exchange rate closely followed the differentials in yields. When German yields rose compared to US yields, capital inflows to the euro area increased demand for EUR, which lifted the exchange rate.
Similarly, when US yields rose compared to German yields, capital inflows to the US increased demand for USD, and the EUR/USD pair fell (meaning a stronger USD.)
The dots you see on the chart are the individual bond yields (DE02Y and US02Y), because I like to have a picture of why the yield differential line is rising or falling (i.e., did the line fall because US yields are higher, or because German yields are lower?)
We are using the 2-year yields, because they tend to closely follow the monetary policy stance of the respective central bank. In other words, when the ECB turns hawkish, the DE02Y tends to rise (signaling higher interest rate expectations), which in turn would push the yield differential line higher (and most likely the EUR/USD pair as well.)
In the next part of Intermarket Analysis, we'll take a look at how other markets can impact currencies, like metals, commodities, and energy.
Please hit the "Like" button and follow, so you won't miss future trade ideas and educational posts!
Intermarket analysis refers to the analysis of other asset classes that can provide valuable and actionable insights into related markets, such as forex.
In this part of our Intermarket analysis lesson, we'll be focusing on a specific asset class that has a very close connection with currencies: the sovereign bond market and yields.
As you already know from my previous educational posts, currencies tend to follow interest rates. With the fall of the Bretton Woods agreement, currencies became freely-floating and capital started to move to places with the highest yields, which meant higher returns for investors.
For example, if Australia has a 3% interest rate and Japan a 1% interest rate, investors could buy AUD to collect a 3% rate and short JPY by paying a 1% rate, leaving them with a net profit of 2%. This is how carry trade work, and the long AUD/JPY was one of the most popular carry trades given the large yield differential between Australia and Japan.
That's why you need to follow yield differentials in your trading. The chart above shows the EUR/USD pair, and the 2-year yield differentials between 2-year German bonds and 2-year US bonds. Notice that we're using German bonds (also known as "bunds"), since Germany is the largest European economy.
To add yield differentials to your chart, simply hit the "+" (compare) above your chart and type in "DE02Y - US02Y" with a space between the symbols. This also works for other currencies. Here is a list of symbols for the major currencies and their respective bond yields: US02Y, CA02Y, GB02Y, DE02Y, JP02Y, AU02Y, and NZ02Y. The currency should be self-explanatory from the symbols (note, we also the German 2-year yield when analyzing CHF.)
Notice how the exchange rate closely followed the differentials in yields. When German yields rose compared to US yields, capital inflows to the euro area increased demand for EUR, which lifted the exchange rate.
Similarly, when US yields rose compared to German yields, capital inflows to the US increased demand for USD, and the EUR/USD pair fell (meaning a stronger USD.)
The dots you see on the chart are the individual bond yields (DE02Y and US02Y), because I like to have a picture of why the yield differential line is rising or falling (i.e., did the line fall because US yields are higher, or because German yields are lower?)
We are using the 2-year yields, because they tend to closely follow the monetary policy stance of the respective central bank. In other words, when the ECB turns hawkish, the DE02Y tends to rise (signaling higher interest rate expectations), which in turn would push the yield differential line higher (and most likely the EUR/USD pair as well.)
In the next part of Intermarket Analysis, we'll take a look at how other markets can impact currencies, like metals, commodities, and energy.
Please hit the "Like" button and follow, so you won't miss future trade ideas and educational posts!
