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The yield spread between the two year US treasury and UK Gilt has increased steadily, tilting the balance in favor of the US. The differential has risen sharply since the mid of 2014, as the Fed was nearing to the winding of its QE programme.
The following chart is the monthly chart of the differential between US & UK treasury yield since 2011. This spread has very high correlation with the exchange rate. This particular graph has inverse relation with the Pound-Dollar exchange rate as we subtract the Gilt from Treasury.
Inflation so far has steadied in the US though below the comfortable levels, whereas fallen in the UK. Fed has more room for the initial rate hike looking at the level of inflation (1.6%, 2014 average).
- As long as the differentials remain tilted in favor of US, we continue to favor the dollar against pound over time.
- As the Federal Reserve has maintained its position of rate hike somewhere in 2015, we also believe the treasury yields to outperform that of gilts.
