FX markets subdued in run-up to US employment data announcement

Publication date: 3 August 2012
Author: Simon Smith, FxPro

Tagged with: Simon Smith

After the drama of yesterday’s session, FX markets are relatively subdued in the run-up to the US employment data later today. It’s actually bond markets where the interesting moves are and FX markets should take careful note. This is because, whilst the more closely-watched 10yr yields in Italy and Spain have moved higher (Spain now around 7%), the yields on short-dated paper have fallen substantially. Spanish 2yr yields are below 4.50%, having been up to nearly 7% in July.

The reason is the ECB’s statement of yesterday that any revised bond-buying on its part would be concentrated on shorter-dated bond maturities, the reasoning being that this fits more closely with its mandate. Traditionally 2yr yields correlate better with FX rates, compared to 10yr bonds. Of course, for the eurozone, there is no such thing as a single bond market. If we use swap rates (i.e. money market rates) instead of bonds, the correlation between EUR/USD and 2yr rates (US vs. eurozone) has averaged around 0.33 compared to almost flat for the 10yr. That said, the inverse correlation between movements in peripheral yields and EUR/USD (euro rising as yields in Italy and Spain etc. fall) has been pretty strong, averaging -0.50 so far this year. If we do the same for the 2yr, the figure is -0.43. Not a massive difference, but notable that it is not as strong. What it means is that FX is more sensitive to interest rates at the short end of the curve (2yr), but more sensitive to sovereign risk at the longer end (10yr). This makes sense from the perspective that governments do issue a greater proportion nearer to 10yr maturity than 2yr on average. But it’s worth keeping an eye on, especially if governments shift to issuing more shorter-dated bonds as a result.