Key Highlights

• Investor exposure to APAC assets rising materially, with FX leading the way
• Local central banks have cited equity interest, but fixed income allocations also have potential
• Divergence between energy and mining holdings suggests lack of investor focus on growth risks

View chart pack

Cross-border investors are moving heavily into APAC currencies, rest of EM generally stagnant

EXHIBIT #1: MONTHLY SMOOTHED FLOW INTO APAC FX VS. EM FX

_{Source: BNY iFlow}

When tariffs were first launched, exporting nations across the Asia-Pacific were expected to suffer greatly from a loss of earnings in U.S. markets. To compensate, broad-based currency depreciation was expected. Contrary to almost all expectations, currency moves have gone completely in the opposite direction as APAC central banks are now scrambling to prevent their currencies from appreciating excessively. Markets clearly believe the new global balance of payments equilibrium entails a weaker dollar and a loss of the dollar’s status. Therefore, current account surplus economies in the region will have to bear the brunt of the adjustment.

Our take

Our data show that flows into APAC FX have surged relative to peers, especially elsewhere in EM (Exhibit #1). Prospects of lower yields in the U.S. and globally have reduced demand for the carry trade, and some funding positions in the JPY, CNH and TWD have clearly unwound. However, recent lines of questioning to central banks in the region suggest that policymakers are more tolerant toward exchange rate strength, even with the loss of export earnings. Given the current U.S. administration’s desire for a new currency framework which would entail a weaker dollar, there is a lingering view that APAC FX appreciation is a potential concession to Washington D.C. as trade talks pick up pace. 

Forward look

The policy response across APAC differs sharply at present. For example, while the lack of intervention in Taiwan has allowed the most significant strengthening in the TWD in decades, the Hong Kong Monetary Authority  (HKMA) is also spending record amounts defending the currency board. Due to regional trade exposures, APAC currencies also need to observe how the CNH performs rather than fixate on the dollar. We doubt there is a concerted effort toward a new global currency accord, but the gradual decline in U.S. demand – due to tariffs or otherwise – will reduce the level of surpluses available for purchases of U.S. assets. Ultimately, savers of surplus economies are the marginal buyers of dollars against their own currencies, and their preferences are changing.

Rate cuts not precluding rise in APAC real yields as headline inflation continues to fall

EXHIBIT #2: FLOWS INTO APAC SOVEREIGN AND CORPORATE BONDS

_{Source: BNY iFlow}

In the short term, APAC financial authorities have highlighted that foreign interest in local equities has returned. This is broadly in line with the general recovery in global risk appetite. We believe the impact of such flows on local currencies is overstated, but the asset allocation case is sound. Equities aside, we also see strong potential for flows into local fixed income markets – an area where global dollar portfolios have been materially underweight over the past few years.

Our take

Across APAC, inflation continues to surprise to the downside as headline inflation continues to decline. All economies in the region are net energy importers and terms of trade have shifted materially in their favor as a result. Domestic demand is also traditionally weak in APAC, which means there won’t be as strong a headline-core divergence as is normally seen in G10 economies. Even though headline rates are gradually coming down in the region, we expect real rates to remain resilient. This is not a new phenomenon as even with low nominal rates, real rates in Japan and China have been considered excessively high throughout recent economic cycles. The difference now is that there are few alternatives in EM or G10 to attract fixed income interest and investors are looking for safety in savings-heavy economies.

Forward look

Our data show that there has been a surprising pick-up in corporate interest in APAC (Exhibit #2). Given the similar credit profile to equities, the flows indicate that financial conditions are expected to loosen through rate cuts, which generates a favorable environment for spread contraction and performance in duration. Corporate preference also supports the view that nominal government bond yields remain too low. As greater issuance arrives with stronger fiscal impulse, larger government bond markets will also look more attractive, potentially strengthening flow momentum into the region.

Global energy stocks continue to underperform but growth warnings ignored by materials sector

EXHIBIT #3: SCORED HOLDINGS OF GLOBAL ENERGY VS. METALS AND MINING STOCKS

_{Source: BNY iFlow}

Weakness in energy prices is supporting the improvement in global real yields and the recent decisions by key OPEC swing producers to prioritize market share will only increase downward pressure on prices. However, we stress that the trigger for prolonged weakness in energy prices has always been demand weakness. Even with stronger fiscal impulse in APAC and EMEA, global growth expectations have taken a tariff-related discount and are unlikely to improve. This is being reflected in energy company valuations, but other growth-sensitive sectors such as mining have not adjusted in kind.

Our take

High gold prices may have contributed to the strong performance in mining, but we believe the valuation gap is now disproportionate. Current holdings in global metals and mining stocks (Exhibit #3) were broadly aligned with holdings in energy at the end of January but now there is a gap of approximately 15%. Furthermore, on an absolute basis metals and mining holdings remain close to February levels. There are almost no reflection of downward revisions to global growth over the past month given these changes have a material negative impact on commodity prices. While supply issues are less pertinent to metals and mining, the global demand component requires a commensurate discount.

Forward look

It is possible that hopes for fiscal stimulus, especially by China, continue to support the sector. Beijing’s repeated assurances that the growth target will be reached points to 1-1.5pp of GDP in fiscal stimulus. A repeat of the 2009 credit surge will certainly help commodities on a forward basis. However, the country has moved squarely away from real estate and fixed-asset investment, and consumption is the new focus. Even if the fiscal numbers are realized, the commodity impulse will be weak. Energy discounts may also look excessive for now, so some valuations convergence between the two industries warrants a closer focus among equity allocations.

Bottom Line

As the U.S. works through potential growth and supply disruptions in tandem with trade talks, asset allocation exposures are increasingly looking for a more positive result in APAC, including China. Even if trade does not recover to previous levels, the realization that domestic and global imbalances need correcting is dawning upon policymakers and investors. Decades of surpluses being channeled back into domestic households will fundamentally restructure economics in the region, but the U.S. has forced the issue. Short-term growth shocks to export segments need to be managed through fiscal and monetary smoothing, but long-term revaluation of APAC assets is commencing, and the tolerance of central banks for FX gains in a disinflation environment suggests a realization that there is no going back to the old export-driven growth models.

Chart pack