Intraday Market Thoughts

Bunds Treasuries Spread Breakout

by Ashraf Laidi
Apr 5, 2023 17:37

The chart showing the spread between the 10 yr German Bund yield and its US counterpart (GER minus US not the inverse) is one of those constructs with plenty of fans & many critics regarding their effectiveness in predicting FX moves. I too have mixed views about this approach to FX, but I did use it with success 3 years ago, referring to the multi-year cycles on to help me predict EURUSD would hit $1.10 in late 2020. The prediction was made at the NY Money show on 8th of March 2020 in this video . You all remember what happened on March 8. It was the INFAMOUS SUNDAY when “Saudi broke OPEC”, leading to a collapse oil, bond prices and gold, forcing the Fed two weeks later to ignite the biggest QE round in history. Let's explore the weakness of using yield spreads before pointing to their strengths below.

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Bunds Treasuries Spread Breakout - Bunds Trsrs Spread Apr 5 2023 (Chart 1)

  When Yield Spreads Failed in FX

See how EURUSD remained steady in spring-winter 2020 despite the Bunds-Treasuries spread falling. The reason was related to the fact that USD was sunk by trillions of fresh central bank liquidity, even as US yields were starting to stabilize relative their German counterpart. Other examples of the yield spread's ineffectiveness was during 2002-2004 –when a rising EURUSD rode on the back of an implicit USD-depreciation policy from the Treasury as well as the start of the commodity boom.

When Yield Spreads Worked in FX

As for the classic examples when Bunds-Treasuries yield spread proved effective in predicting EURUSD, these were in 2000-2002 and 2011-2017.

Looking ahead, the Bund-Treasuries 10-yr yield spread appears to be breaking above the trendline resistance (upper right corner of chart). Yet, the spread needs to ascend further towards the -0.50 territory (when bund yields are -0.5% below treasuries) in order for $1.10 to hold and build up for $1.15. The warning becomes the following: Once/if the break into positive territory (spread goes above zero%), the FX implications, could be significant (in propsects and in speed) for EURUSD due to algos deploying new buy orders, on such massive Global Macro developments. As for the fundamental triggers, they could include: i) New evidence of weakness in US labour markets; ii) signals of Fed pivot (definite pause in hikes); or even iii) Japan nearing the end of YCC. Think deeply about the last one, as it's not straightforward.



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