My understanding is if bond yields increase it creates demand for a currency. But that means bonds are being sold if yields are increasing? So if bonds are being sold and not bought, thus not creating demand for a currency, why do currencies have a positive correlation with bond yields?
Can you see why I’m struggling? Sorry if stupid question.
In: 6
The easiest way to understand demand for a currency is to think of it as the *demand for involvement in a given economy*. If you want to buy US goods, invest in US companies, or own US bonds, then you need USD.
If USD bond prices decrease, then USD interest rates go up. Higher interest rates are more attractive to investors, which drives demand for USD.
Another key consideration is inflation. As interest rates increase, it gets more expensive to borrow money. This slows down business investment activity and cools the economy overall, which reduces inflation. If price levels in the US are lower than in other countries, US goods become more attractive to import, driving additional demand for USD.
The actual act of selling bonds isn’t a big driver of exchange rates on its own. It’s certainly a piece of the puzzle, but the interest rate impact on exchange rates is much larger in comparison.
Latest Answers