FX: G10 & EM, published every Thursday, provides a detailed analysis of global foreign exchange movements in major and emerging economies around the world together with macro insights.
John Velis & Wee Khoon Chong
Time to Read: 5 minutes
EXHIBIT #1: RATE DIFFERENTIALS DRIVE DOLLAR
Source: Source: BNY Markets, Bloomberg
Our take
Is the recent weakness of the U.S. dollar a sign of waning U.S. exceptionalism or an indication that dollar dominance is at risk? We don’t think so. After significant appreciation from below 101 in late September, the DXY dollar index touched nearly 110 in mid-January, only to retreat to around 104, where it is presently. As Exhibit #1 shows, this short-term rise and fall is entirely in line with traditional fundamental drivers. The darker line represents the spread between the weighted average of 2y yields of all currency pairs in the index and that of the U.S., and the lighter line is the DXY index itself. The adherence of the dollar to this interest differential is quite apparent, save for the brief period in late December and early January highlighted in the chart, which coincided with the final throes of the dollar’s post-election bounce.
Forward look
Growth expectations and sentiment surveys have been weakening recently, and with them, increasing expectations of further policy easing from the Fed. Currently the market is pricing over three rate cuts by the end of the year, more than the two cuts indicated in the FOMC’s most recent Summary of Economic Projections. While our own projection is still for two cuts this year, we acknowledge (and wrote about here) the downside risks to policy rates, especially if the hard data begin to follow the soft data. If this were to occur, we think the rest of the world would register similar downside economic developments, keeping this rate differential and the dollar steady at around these levels.
EXHIBIT #2: CAD CROSS-BORDER FLOWS
Source: BNY Markets, iFlow
Our take
In the 85 trading days following the U.S. election, cross-border flows into the Canadian dollar were negative on 67 of them, reflecting concerns over Canada’s position as one of the epicenters of the U.S. administration’s trade policy. The downside risk to Canadian growth is obvious. The 2y rate differential between Canada and the U.S., which represents relative monetary policy expectations, is now over 140bp, close to the widest gap observed in recent history. While the market is currently discounting only about 50bp in cuts for the Bank of Canada through the end of the year, and the U.S. is now priced for more than that, there is an argument for the CAD to stick around the 143-145 range until things change.
Forward look
BoC Governor Macklem recently highlighted the inflation risk that tariffs and potential retaliatory measures pose. This risk is behind the pullback in the market’s rate cut expectations from Ottawa and is also probably responsible for the brief period of strong cross-border inflows highlighted in the chart. However, our own expectation is that growth will disappoint in Canada. Bloomberg consensus reports that the probability of a recession there have risen to nearly 50%. This will probably increase the number of expected rate cuts. Our view on interest rate differentials driving USD movements applies to the USD/CAD cross, creating upside risk to this pair, potentially above 1.45 eventually.
EXHIBIT #3: APAC FX SCORED HOLDINGS AND CHINESE EQUITIES SCORED FLOWS
Source: BNY Markets, iFlow
Our take
Both the Chinese yuan and the Shanghai Composite have been sounding a cautious tone, with both moving in a relatively tight range, despite positive economic data. The Chinese PMI manufacturing and nonmanufacturing indices are in expansion territory, and retail sales, credit and investment data have all improved. Outside of China, regional growth momentum has deteriorated, with the latest March PMI manufacturing index indicating that Thailand, Taiwan, the Philippines, South Korea and Malaysia are all in contraction. Global de-risking sentiment, ongoing U.S. tariffs and uncertainty about reciprocal tariffs, along with domestic political and expansionary concerns in select countries have led to a breakdown in the correlation between APAC currencies and the U.S. dollar. The former had traded sideways despite a correction of over 3% for the broad dollar in March. There has also been wide variation in asset performance in APAC, where some conventional relationships between equities and FX performance no longer hold true. This is most notable in Thailand, with a flat THB compared to a -16% selloff year-to-date and the relatively stable USDTWD against a -8% selloff and over $18bn in foreign equity outflows year to date.
Forward look
Despite relative APAC foreign exchange inaction, underlying FX flows are much better than implied by the price action. As Exhibit #3 shows, there has been persistent inflow momentum into APAC currencies since the beginning of the year. This has pushed APAC scored holding from the lows reached at the end of 2024 to the least underheld condition since October 2024. We think the bulk of tariff risk is priced in, leaving the equity flow dynamic as one of the top drivers for APAC FX, along with monetary policies.
We are encouraged by the ongoing demand in Chinese equities, with iFlow posting five straight weeks of net inflows, the longest buying streak since February 2023. Across the region, there are tentative signs of exhaustion after record year-to-date foreign equity outflows. Moving forward, APAC FX performance will be a tug of war between domestic policy stimulus against exogenous equity flows and the impact of tariffs.
