Bond spread refers to the difference between bond yields of various countries. These differences have led to arbitrage transactions.

By monitoring changes in bond spreads and interest rate expectations, you can know how the currency mix is going.

As shown below:

The bond spread between the two economies has increased, and the currencies of countries with higher bond returns have appreciated relative to the currencies of countries with lower bond returns.

You can find this phenomenon by observing the price behavior of AUD/USD from January 2000 to January 2012 and the bond spreads between the 10-year government bonds of Australia and the United States shown in the chart above.

Note that when the bond spread increased from 0.50% in 2002 to 1.00% in 2004, the AUD/USD rose by nearly 50%, from 0.5000 to 0.7000.

This phenomenon also occurred in 2007. When the bond spread rose from 1.00% to 2.50%, the AUD/USD floated from 0.7000 to 0.9000. That was 2000 points.

When the recession came in 2008 and all major central banks began to cut interest rates, the AUD/USD fell from 0.9000 to 0.7000.

What happened?

One of the reasons is that traders are beginning to use arbitrage trading.

When the spread between AUD bonds and US Treasury bonds rose, they bought a lot of AUD/USD.


Use arbitrage transactions.

However, once the Central Bank of Australia begins to cut interest rates and bond spreads decrease, traders will reduce their holdings in AUD/USD, thinking they are no longer profitable.