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Yield Curve Interpretation

  On this page you will learn about using Bond Yield Curve Interpretation to generate signals for forex trading.

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Yield Curve Interpretation

The yield curve is one of the most important tools that those who trade forex online can use for understanding the direction of the economy. The tendency of an inverted yield curve to predict recessions well in advance, for instance, is well known. So is the common maxim that the steeper the yield curve, the greater the profitability of the finance sector, and often their willingness and power to lend to the business sector, leading to a higher potential growth rate over time. In this artcile we’ll take a look at the various ways in which knowledge about the yield curve can be utilized for a better trading performance.

An important point to keep in mind while analyzing currencies and the interest-rate gap is that the central bank rate is representative of only a small part of the attractiveness that each currency presents to investors. Yields on the longer term, yet still on the left-side of the curve are often more important, due to the higher yield coupled with still high liquidity that these maturities offer. It is common to see the forex market react strongly to changes in the 2-year yields of government paper, as traders shift actual assets from one country to another, as well re-assessing the future economic potential of the economies.

The bond market is dominated by very powerful financial actors with a lot of analytical power and resources to back their research and justify their trading plans. As a result, the bond market is often regarded as where “smart money” as it is termed, makes its plans and decisions most evident. Traders can use this knowledge to to discount fluctuations in other markets where they contradict the established consensus of bond traders. For example, assuming that the bond market signals a recession with a inverted curve for a long time, while the carry trade keeps rallying and stock investors remain bullish, depending on his own analysis, a trader may begin to short the two latter markets in anticipation that a correction is in order. The crucial point here, of course, is to establish your position gradually. At the earliest stage only insignificant amounts should be risked, with exposure being increased as the preferred scenario is confirmed.

Central banks are attentive to the yield curve as well. The present head of the ECB, M. Trichet, for example, will often make references to the shape of the yield curve in his press conferences. If the yield curve is not in agreement with the policy intentions of a central bank, the institution is mostly likely to intervene verbally, upsetting trader consensus, leading to market upheaval, and reestablishing market balance in the intended direction. It is possible to exploit this situation by siding with the central banks, entering counter-trend trades when the market does not follow their guidance. Central banks can also be mistaken at times, but they have a lot of power, so it is a good idea to

It is possible to create many forex strategies, but any strategy that keeps the yield curve in perspective will have added degree of viability in most cases. It is up to you to improve your understanding of this important concept, but when you do, it will surely be a great profit multiplier to your trading.


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