After remaining in a tight range between December and January US Treasury yields have broken out to the upside and are currently trading at 3.68%, as you can see in the chart below. Friday's shock improvement to the US unemployment rate was the catalyst for the break out in yields.

US 10-YR Treasury yields


In the absence of much economic data today, this leaves interest rate differentials they key driver of markets.

The analysis below looks at the spreads between major government bond yields and US Treasuries:


EURUSD (German 10-yrs and US-10-years) - the spread has narrowed sharply causing a reversal in EURUSD below 1.3626 - the Ichimoku cloud top. Although this has thwarted euro gains, the spread might have moved too far and could be due a period of consolidation, which could help stabilise EURUSD for now. Above 1.3626 suggests we could push higher once again.


GBPUSD: Although the spread has narrowed in the dollar's favour, GBP has continued to trend higher. Since the spread and GBPUSD tend to move together the divergence between the two is unlikely to last. Due to the hawkish bias of the MPC relative to the Federal Reserve we think that the spread will reverse and continue to widen, thus supporting GBPUSD toward 1.6240 - the recent highs.


USDJPY: Break out in the spread supports further USDJJPY gains. The spread has widened significantly in recent days and USDJPY may play catch-up. We could see toward 83.00 in the near-term. The dovish bias of the Bank of Japan and the weakness in Japanese economic data (Q4 2010 GDP is expected to turn negative when it is released next Monday), should support the interest rate differential and thus USDJPY.


USDCHF: Like Japan, the US-Swiss 10-year government bond yield spread has widened sharply, boosting USDCHF. The spread suggests further gains for USDCHF, possibly back to January's 0.9700 highs. Like Japan, the dovish tone to the Swiss Central Bank's rhetoric of late should continue to support USDCHF.


USDCAD: The spread between US and Canadian yields has widened, however USDCAD has fallen,. This is because of Canada's close economic ties to the US. A more positive outlook for the US jobs market is good news for Canada, hence the CAD has rallied strongly since Friday. However, USDCAD is close to record lows, so it will take a major push from the CAD bulls to go lower from here, so we would not be surprised to see a period of consolidation here.


AUDUSD: The spread between Aussie and US 10-year yields continues to narrow, albeit from a high level. This caused AUDUSD to flounder in recent weeks, but Aussie is now being driven by higher commodity prices. Even if the spread narrows further, as long as commodity prices continue to rally then AUDUSD should remain supported.


NZDUSD: The spread between Kiwi 10-year yields and US yields has collapsed, dropping nearly 100 basis points since November as the economic outlook in New Zealand has deteriorated. This has pushed down NZDUSD. A break below 0.7680 - the 21-day moving average, suggests that the bias is lower and the Kiwi could experience further declines. But due to the sharp move lower in the spread NZDUSD may need to play catch up and there could be further declines for the pair, but expect a period of consolidation first.


The dollar has rebounded since the unemployment report last week, however it is not strong across the board. While all of the major spreads have moved on the back of higher US yields, the biggest impact on FX spreads are the dollar vs. the euro, yen, Swissie and Kiwi.

In contrast the pound, the Cad and the Aussie dollar are all still strong against the greenback due to the following factors:

  •  Firstly, the spreads have not widened as much in the dollar's favour
  •  Secondly, UK interest rates are becoming more of a close call due to persistent inflation pressure, and the Bank of England is increasingly looking like it may be the first major central bank to hike rates which is boosting the pound.
  •  Thirdly, the Aussie is getting a boost from higher commodity prices.
  •  Lastly, the Canadian dollar improves when the US economic outlook is brighter, so stronger Treasury yields on the back of an improved outlook for the US economy is Cad positive.


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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