Using bond spreads in your forex trading strategy

Whether you are dealing in the currency market, commodity market or the equity market they are all interconnected. The various markets also impact each other; it is not unusual to see a movement in the commodities or futures market influencing the trading session in the currencies market. An identical relationship also exists between currencies and bond spreads. A bond spread is the difference in the interest rate of various countries. Macroeconomic principles state that there is a direct relationship between inflation and currency strength. A weaker currency will increase inflation while a stronger currency will help to stop and even reduce inflation. So, the price of a currency makes a very big difference to the monetary policies of the countries around the world. These monetary policies and decisions coupled with interest rates in turn control the price of currencies.
Understand the impact of these occurrences on the currency market will give a trader insight into the movement of the market and will help in predicting the movement of currencies.

To understand the impact of interest rate on the currency market you need to look back at the tech bubble burst of 2000. Traders changed their market goals during this period and were then looking for capital preservation over high returns. The US interest rates at the time stood at 2% and there was a possibility that the Feds would cut it further. However the Australian interest rate was 5%. This presented a lucrative opportunity to hedge fund managers and other establishments that could trade overseas. The risk factor in the Australian and US markets were the same which meant that a profit of 3% could be made in the Australian market. This significant difference in the interest rate brought forth the concept of carry trade.

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