With global economic growth already showing signs of slowdown, the correlation between growth fears and bond prices are important indicators of economic outlook. If the market turns bullish or bearish, then the probability of central banks cutting interest rates will have an enormous impact on currencies.
When investors are pessimistic about economic growth and thereby inflation and probability of central banks cutting rates remain high, the rally in bond prices will lower bond yields. Hence, recent examples of the Reserve Bank of New Zealand (RBNZ) unexpectedly hinting at an upcoming interest rate cut and reinforcing a weakening global economic outlook drove the Aussie (AUD/USD) down by approximately 0.57% off the announcement 27th March.
Thus, New Zealand’s 10-year government bond yield plummeted to a record low of 1.75% on Wednesday and other bond markets including Australia, US, and Europe were all consequently impacted (see Chart 1). This trigger of a more dovish RBNZ meant the AUD moved down in correlation with the Kiwi and USD moved as a response to its 10-year note approaching close to an important technical level 2.40%.
Similarly, the inverted US yield curve signals that investors are turning more pessimistic about economic growth, inflation, and chance of interest rate hikes. This yield curve inversion is also at times a grim outlook of an upcoming recession (see Chart 2). Since the yield curve consists of Treasury yields with various maturities, the yield curve would normally slope upwards as long-term government bond yields are generally higher than short-term bill yields to compensate investors for inflation and its longer maturity. But if the curve flattens then investors are expecting that future economic growth is slowing, and if yield on bills rise above 10-year Treasuries – the possibility of an economic downturn and recession increases.