Factors impacting bond yields

[o.menary11]

Hi,

How does the exchange rate impact a conventional bond yield?

Thanks!

 

[mugono]

The relative change in the value of a country’s currency affects its attractiveness to internationally mobile investors.

eg Sterling reduction relative to USD will affect the attractiveness of UK denominated assets. So I would expect the yield on conventional bonds (UK) to increase and its price to fall.

 

[James Nunn]

I agree with Mugono's answer, but there is a bit more detail that may be of use - I set this out below in case it is.

If the currency depreciates, short term interest rates would be expected to increase to reverse the fall in demand for domestic currency - eg due to the exit of 'Hot Money' (international investment that moves fluidly around the world chasing the best returns). The expectations theory of the yield curve (or the fact that money market instruments can be seen as substitute goods for short term bonds) would then suggest short term bond yields will increase as a result of this; prices of these bonds will therefore then fall.

However, the impact on longer term bonds is less clear and will depend on what will happen to expectations of short term interest rates will be in the longer term future (ie over the whole term) and this may be less clear given we don't necessarily know what will happen to short term interest rate expectations in the longer term - both due to exchange rate changes and more generally.

Hopefully this is helpful.