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Friday, March 23, 2012

Yield Curve

We have borrowed some text from FX Words  (
This is the basis for our service which we’ll explain below.
The yield curve describes the relation between the interest rates and the maturity dates of debt instruments for a given currency (such as bonds and other related securities). For example, FX traders often study the yield curve between the US dollar interest rate paid out to US Treasury securities with varying maturities. Typically, the yield curve is upward sloping asymptotically, suggesting that higher yields are offered to securities with longer maturities. This is referred to as the 'normal' yield curve. However, yield curves can also be inverted, or humped in shape.

Normal Yield Curve
As stated above, the normal yield curve describes a positively sloping curve indicating that larger interest rates are associated to securities with longer maturities. Generally, this reflects the fact that most traders expect the economy, and inflation, to grow in the future. An increase in inflation is generally accompanied by tighter monetary policy and an increase in short-term interest rates by the Fed in order to slow growth and pressure from inflation. Thus, traders will ask for higher rates of return on securities with longer maturity dates in anticipation of higher future interest rates in general.
Inverted Yield Curve
An inverted yield curve, as the name implies, inverts the relationship described in the normal yield curve. Paradoxically, long term yields fall under short term yields, indicating a negatively sloped curve. This trend indicates an expectation of a receding economy in the future, or a belief that the market will not exhibit any continuing inflation. Overall, low or negative expectations about future conditions might cause this kind of yield curve, as demand for short-term investments exceed long-term, driving up the interest rates on securities with a lower maturity date.

Although the correlation is not prefect, but inverted yield curves have preceded numerous recessions in the past.

Humped or Flat Yield Curve
In a Flat yield curve, all maturities offer the same yield, while in a Humped yield curve, long term and short term maturities offer the same yield while middle term maturities offer varying return interest rates. Generally, these kinds of curves hint at overall uncertainty about the future and usually shift towards a normal or inverted curve as more information is made available.

Overall, yield curves are important to FX traders as it offers what amounts to be the sum expectations of all market participants on future interest rates. Yield curves are one of the best indicators of the future performance of an economy.

Our service:
Taking the 10 year (10Y) yields for each currency we calculate the returns for the pair and track it with several updates throughout the day. Simple enough right? I found this information extremely useful when trading the pairs. It is important to mention that this information is mostly tailored to day-traders. We plan to update this every week on Fridays! a good summary of the week and a good reference for the next one.

10 year yield comparisson for selected FX pairs. Each point corresponds to a trading day, the last one being March 23 2012. The time frame in the upper corner is only a reference for when the pairs are not heavily traded in the European market.

Remaining pairs for week 12 (19 March-23 March 2012)