For the past two to three months the correlation between the bond market and currency market has been patchy at best, frustrating many traders who rely on this metric for trading opportunities. But looking at the charts again suggests that the correlation could have returned.
What are we looking at?
Forex currency pairs are driven by interest rate differentials. Interest rate differentials are the gap between the interest rates of two currencies. Traders pay attention to this because currencies with higher interest rates tend to attract more buyers, while lower yielding currencies are often used for funding.
USD/JPY often moves in correlation with U.S.10 year yields. When the US10Y rises it suggests that interest rates could remain higher in the US which attracts foreign investors, on the other hand lower interest rate yields can push investors away, as they seek out higher interest rates.
Recently, the link between the two assets were disrupted by Donald Trump’s trade tariffs which could become front and centre again on August 1st, where the next tariffs are meant to come in.
Is this correlation back?
When we take a closer look at the two charts together we can see that at the beginning of this year the correlation between the two assets was very strong.
However, between April and July the correlation was all over the place. This made it very difficult for traders that rely on this information to make trading decisions.
Looking at the two assets at the beginning of this month (July) we can see the movements are very similar and highly correlated. Which suggests that we could look for one market to lead the other, which is super helpful for retail traders.
How to use this information
For retail traders, the return of the USD/JPY and U.S. yield correlation is a big deal because it gives you a clear macro signal to lean on again. When the correlation weakens, USD/JPY can feel random, swinging on risk sentiment or short-term positioning. But now, with the correlation looking like it’s back, watching U.S. Treasury yields can act as your early warning system for USD/JPY moves.
Keep a close eye on this, and understand that correlations come and go, but when they’re in form they can be extremely useful.