How Bond Yields Affect Exchange Rates

Government bond yields are one of the most powerful drivers of exchange rates. Understanding this relationship helps explain why currencies strengthen or weaken — and can help you time your exchange better.

The Basic Principle

When a country's bond yields rise, its currency tends to strengthen. Higher yields attract foreign investment — global investors buy that country's bonds to earn better returns, and they need to buy the local currency to do so. This increased demand pushes the currency's value up.

Interest Rate Differentials

What matters most isn't the absolute yield level, but the difference between two countries' yields. If UK gilts yield 4.5% and US treasuries yield 4.0%, the 0.5% differential favours the pound. If US yields then rise to 4.8%, the differential shifts in favour of the dollar.

Real Examples

• USD strength (2022-23) — The Federal Reserve raised rates aggressively, pushing US yields above most peers and driving the dollar to multi-decade highs
• JPY weakness — The Bank of Japan kept yields near zero while other countries raised rates, causing the yen to depreciate significantly
• GBP volatility (2022) — The mini-budget crisis sent UK gilt yields soaring for the wrong reasons (fiscal concern, not growth), and the pound initially crashed rather than strengthened

Why Context Matters

Rising yields don't always mean a stronger currency. If yields rise because of inflation fears or fiscal instability (rather than economic strength), the currency may actually weaken. Markets look at why yields are moving, not just the direction.