Thursday, May 7, 2009

G10 yield compression from similar policies




With volatility falling and our risk appetite index increasing, carry returns have returned. However, the return of carry is a focus on emerging markets and is not associated with the G10.The economics is easy to see once you look at the yield compression across the G10. If there is no yield differential, there is no potential for carry. Our graph shows the difference between the maximum and minimum yield spreads against US rates for 2-year maturities. This could be a good proxy for the differences in monetary policy. Through this proxy, we are seeing a convergence of policy initiatives which makes exchange rates more difficult to forecast.

If everyone is doing the same thing, then relative prices ill not move. Small changes in economics will have big impact on exchange rates.


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