The US 10Yr Treasury yield crossed the 5 per cent mark last week for the first time since October 2023. Crude oil prices, surging from around $90 per barrel in the beginning of this month to $109 last week, had pushed the Treasury yield higher.

The US Federal Reserve increased interest rates by 25 basis points (bps) in its meeting last week. Its economic projection has kept the doors open for another 25-bps rate hike for this year. This is aiding the 10Yr Treasury yield to sustain around the 5 per cent mark.

Government bond yields surging to multi-year high is not a specific US phenomenon. Indeed, the yields in major economies such as Europe, Japan and the UK are also at multi-year highs now.

Germany’s 10Yr Bund yield is now at a 15- year high of 3.5 per cent. UK’s 10Yr Gilt yield, currently at 5.3 per cent, is at an 18- year high. Japan’s 10Yr Government Bond yield had touched a 30-year high of 3 per cent.

In this article, the impact of high yields is not discussed. Instead, we will see how the differentials in the yield between two countries impact the currency movement. Before diving into that, let us see what is driving the bond yields now, especially the Treasury yields.

The drivers

The US Federal Reserve Chairman Kevin Warsh highlighted in his press conference last week the three major factors that are pushing the yields higher — economic strength, competition for capital resulting in a surge in capital expenditure and geopolitical issues.

Out of the three, the geopolitical issue — the ongoing US-Iran war — is one common factor that could be driving the yields across all major economies. Inflation worries have gone up ever since the war began as crude oil prices have surged since then. Higher inflation expectations have a direct correlation with the bond yields, as it will strengthen the case for the central banks to increase the interest rates.

Rate hike cycle

The Fed Chairman Kevin Warsh mentioned in his speech last week that inflation remains elevated and the risks are on the upside. Oil prices are likely to stay higher unless the US-Iran war ends. So, inflation across the globe is likely to go up and stay higher until then. That, in turn, can continue to keep the bond yields higher as the central banks can increase interest rates to fight inflation. 

The US Fed, in its meeting last week, increased interest rates by 25 bps. The Fed Fund rate currently stands at 3.75-4 per cent. The central bank, in its economic projections, has kept the doors open for one more rate hike this year.

The European Central Bank (ECB) has also been increasing its rates since June this year. Its refinancing rate has gone up from 2.15 per cent in April to 2.65 per cent now.

The Bank of Japan has raised its policy rates from 0.5 per cent at the beginning of the year to 1.25 per cent now.

Major central banks across the world have already begun the rate hike cycle. Elevated inflation is likely to push interest rates higher. Also, interest rates can continue to stay higher unless the oil price falls sharply and sustains lower.

Increasing interest rate scenario is positive in general for the bond yields.

Yield differential

Globally, government bonds are considered a safer investment avenue. The US leads the table in that. Higher the yields, larger will be the investment interest in that particular country.

The difference between the yields, called the yield differential, of two countries play a major role in determining the exchange rate of those two countries.

Assume that today the US the bond yield is at 5 per cent and in Germany, it is 3 per cent. The yield differential between the US and Germany is now 2 percentage points (5 minus 3). A bond investor, residing in Germany, would prefer investing in the US rather than in his own country. The reason for choosing the US bonds here is, simply, better returns.

So, the investor will sell the euro and buy the US dollar to make this investment. This is the currency transaction that happens behind this investment process.

After a month, assume that the bond yield has gone up to 5.4 per cent in the US and 3.2 cent in Germany. The yield differential now is 2.2 percentage points (5.4 minus 3.2). The differential has increased by 0.2 in one month. That is, the yields in the US are increasing at a much faster rate than in Germany. This will make the US bonds more attractive, resulting in more investments in that country.

Consequently, more investors will sell euros to buy more dollars and make their investment in the US — the demand for the euro will go down and that of the dollar will go up. This makes the euro weaker comparatively. In other words, the exchange rate of EURUSD goes down.

To summarise this, higher the yield differential, stronger the currency.

This concept of yield differentials is taken up here to forecast some of the major currencies.

Caveat

Yield differential is not the only factor that will influence the currency movement. There will be other factors also in play. Also, the currency forecast given here is purely based on technical analysis of the yield differential charts alone. So, there is always a risk of the view going wrong.

Also, higher yields in a particular country do not mean that its currency should strengthen. Other factors such as economic strength, inflation condition etc will also play a major role in determining the strength or weakness of that currency.

EURUSD outlook

Germany being the largest economy in the European region, the 10Yr Bund yield is taken as a proxy for forecasting the euro. The differential between the 10Yr Bund yield (3.5 per cent) and the US 10Yr Treasury yield (5 per cent) is currently at -1.5 per cent.

Since the currency euro is quoted as EURUSD, the differential is taken as Germany (EUR) minus the US (USD).

The differential has come down from a high of -1.18 per cent made in April. The trend is down since then. Resistance is at -1.35 per cent. Support is at -1.51 per cent. A break below -1.51 per cent can drag the differential down to -1.7 per cent.

The euro (EURUSD) moves in tandem with this differential. The euro is currently at 1.1486. The German-US yield differential indicates that the upside in the euro can be capped at 1.17-1.18. The fall to -1.7 per cent in the differential can drag the euro down to 1.12-1.10 in the coming months.

Takeaway

The euro is likely to remain weak, going forward. An expected fall in the German-US differential can drag the euro lower.

Pound outlook

The UK’s 10Yr Gilt yield is currently at 5.29 per cent. The Gilt-US 10Yr Treasury yield differential is at 0.29 per cent.

The British Pound is quoted as GBPUSD. So, the differential is taken as UK (GBP) minus the US (USD).

Broadly, the differential has been oscillating in a range of 0.14 per cent to 0.61 per cent for more than a year now. Within that, the differential can come down to 0.2 per cent or even 0.14 per cent, the lower end of the range in the short term.

A bounce from around 0.2 per cent or 0.14 per cent will keep the sideways range intact. In that case, the differential can rise back to 0.5-0.6 per cent again. In case the differential breaks below 0.14 per cent, then a fall to 0 per cent and even lower can be seen.

The range in the differential has kept the GBPUSD (1.3366) also between 1.30 and 1.38 for more than a year now. If the differential falls to 0.14 per cent and bounces back, then the GBPUSD also can test 1.30, the lower end of the range and bounce back.

Takeaway

The UK Gilt-US Treasury 10Yr differential is range-bound for now and is likely to retain the range. This can keep the GBPUSD also in a sideways range.

Yen outlook

The Japan 10Yr Government Bond yield is currently at 2.95 per cent. The US-Japan 10Yr yield differential is at 2.05 per cent. In this case, we take the differential as the US minus Japan. This is because the currency pair is represented as USDJPY.

The long-term trend is down since October 2023 for the differential. However, the price action from the beginning of this year on the charts indicates that the differential is turning up. Support is at 1.78 per cent.

The differential can rise to 2.15 per cent initially. A break above it can see an extended rise to 2.45 per cent. But thereafter the US-Japan 10Yr differential can turn down again and resume the broader downtrend.

The USDJPY and the Japan-US 10Yr yield differential used to move together. But there has been a divergence since June last year. So, the rise in the differential to 2.15 per cent of 2.45 per cent may not take the USDJPY pair higher if the divergence prevails.

If we assume that the positive correlation would come back after some time ( maybe once the differential starts to fall), then USDJPY (157.87) could fall to 150-148, going forward.

Takeaway

Assuming that the positive correlation between the USDJPY and the yield differential comes back, the USDJPY can rise initially and then fall back eventually in the long term.

Rupee outlook

India’s 10Yr Government Bond yield is currently at 7.07 per cent. The US-India 10Yr Bond yield differential is at -2..07. per cent. Since the currency is denoted as USDINR, we take the US minus India as the differential. like in the case of Japan

There is strong support for the differential at -2.34 per cent. A rise to -1.85 per cent looks likely from here. If the differential manages to breach -1.85 per cent, then an extended rise to -1.7 per cent or -1.65 per cent can be seen.

The USDINR and the US-India yield differential broadly move together. There was some divergence from the beginning of 2025 till April this year. Thereafter, they are largely moving together.

So, if the US-India yield differential moves up to -1.85 per cent or -1.65 per cent, then the USDINR can also move up. That keeps the door open for the USDINR (95.88) to reach 98, going forward.

Takeaway

The expected rise in the US-India 10Yr yield differential can take the USDINR pair higher. That is, rupee is likely to weaken more against the dollar.

Published on September 19, 2026