Fundamental evaluation series: 2-year yield spread vs. GBP/USD
Source: FxWire Pro - Commentary / 25 May 2018 09:12:21 America/New_York
The chart above shows, how the relationship between GBP/USD and 2-year yield divergence has unfolded since 2012.
The cozy relationship between the yield spread and the exchange rate, in this case, is quite visible. Back in 2013/14, UK’s economic prowess and the disappointment that the Bank of England (BoE) governor Mark Carney wasn’t as dovish as expected, fueled the increase in yield divergence in favor of the United Kingdom and strengthening of the pound against the dollar. But as economic growth slowed and the BoE expressed a greater desire for a cautious approach, yield spread (UK-US) declined and exchange rate softened.
In 2016, the yield spread has declined sharply into the negative since the referendum date was announced. The actual decline began in September 2015 as the market was speculating that the Brexit referendum will be held in 2016, instead of 2017. The yield spread declined from -0.1 percent in September 2015 to -0.4 percent by early 2016.
A week before the referendum the yield spread between 2-year gilt and the 2-year treasury was trading at -0.36 percent and after it, the decline was very sharp. By October, It declined to -0.65 percent. And the pound has declined from 1.36 against the dollar to 1.25 against the dollar as Bank of England (BoE) introduced several accommodative monetary policy measures including a rate cut. Since the US election that was won by Donald Trump, the yield spread deteriorated sharply to -1 percent.
As a matter of fact, the pound had actually risen since the election. Back in November last year, the pound was trading around 1.235, while the yield spread was at -87 basis points. While the spread widened further towards -121 basis points, the pound is up trading at 1.272 against the dollar.
In our review in August, we noted that the spread has somewhat narrowed in favor of the pound as the Bank of England (BoE) gave out a rare signal of a looming rate hike.
In our mid-September review, we noted that the spread has narrowed by almost 10 basis points, to -99 basis points (UK-US). The pound has moved faster, which is not unusual and has increased by almost 690 pips since our review in August and was trading at 1.356 against the dollar.
We further noted in October that the spread has widened by more than 14 basis points to 113 bps in favor of the dollar and the pound has weakened by 340 pips and to 1.322 against the USD.
In our last review in November, we noted that the spread has widened by almost 15 bps in favor of the dollar to 128 bps, while the pound has strengthened by 30 pips to 1.325 thus adding to the divergence.
In our mid-December review, we noted that the spread has further widened by 10 basis points to 138 bps, while the pound has gained by 140 pips and is currently trading at 1.339 against the dollar, thus contributing to the divergence.
In our January review, we noted that the spread has further widened by 12 bps to 150 bps in favor of the dollar, but the pound has strengthened by almost 900 pips against the dollar and was then trading at 1.423.
In our February review, we further noted that the spread has further widened 12 bps to -162 bps in favor of the dollar and the pound declined by 250 pips to 1.398 against the dollar.
In our March review, we noted that the spread has tightened by 21 bps -141 bps in favor of the pound, which strengthened from 1.398 against the USD to 1.411 against the USD.
In April review, we noted that the spread has again widened from -141 bps to -166 bps in favor of the dollar as Bank of England (BoE) governor Mark Carney indicated a slower pace of rate hikes and the pound has declined from 1.411 in the last review to 1.38 against the USD.
Since that review, the spread widened further by 12 bps to 178 bps and the pound has declined to 1.334 against the USD.
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