Key Highlights

• Cash preference in APAC points to caution amid positivity
• Resilient wage growth not boosting consumption
• APAC and G10 sovereign demand hints at growth fears

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Surge in APAC FX and CAST flow is a combination of safety and policy interest

EXHIBIT #1: MONTHLY SMOOTHED FLOW, APAC CURRENCIES, CASH AND SHORT-TERM INSTRUMENTS

_Source: BNY

Optimism over trade relations between Asian economies has helped APAC assets recover over the past month, to the extent that central banks in the region are beginning to struggle to manage inflows. Through early May, when flows into the TWD and HKD were driving the performance in currencies, we agreed with the general central bank view that these were largely cash transactions seeking to capture equity exposures after the sharp adjustment in valuations in April. However, more recently we have seen a further surge in outright cash flow: cross-border interest in cash and short-term instruments (CAST) has surged to the strongest levels in 18 months. This points to a different dynamic which is not necessarily risk positive.

Our take

We see two current drivers of cash interest, suggesting caution is warranted. Firstly, the prior inflows into equities have probably peaked and some profit-taking is coming through. Should the rest of the month result in multiple trade deals between the U.S. and APAC economies, all the relevant re-pricing based on this topic alone would be complete. Secondly and more importantly, we continue to see interest in diversification interest away from the dollar and any government bond with fiscal risk attached. Naturally, “safety” is seen as strongest amongst economies with heavy domestic savings which can fund higher deficits. APAC continues to find interest in this regard, yet it is a sign that fiscal dominance fears remain a pertinent market theme.

Forward look

Despite efforts by central banks to continue easing in an uncertain external environment, we believe that current interest in APAC FX and cash equivalents will remain high, especially because of the fiscal component. Throughout the past quarter, we have stressed that the dollar remains the most efficient way to reflect risk premia in U.S. assets rather than outright liquidation. We continue to see local central banks trying to manage the price drag from flows, but economic rebalancing for the region is an accepted long-term trajectory. Excessive intervention or currency management risks furthering distortions and future repeats of the episodes seen in TWD in May.

Wage growth is robust in developed markets, but discretionary spending continues to struggle

EXHIBIT #2: HOLDINGS IN CONSUMER DISCRETIONARY SECTORS, EM AND DM EQUITIES

_{Source: BNY}

The latest labor market reports from developed nations continue to point to some upward price pressures from wage growth. Be it non-farm payrolls or the U.K.’s latest labor market report, nominal wages continue to enjoy a light buffer against inflation. However, this is not generating any form of sustained growth in discretionary spending. Global earnings reports are pointing to further withdrawals of guidance or general consumer weakness, and flows are reacting accordingly. Our data show that towards the end of May, holdings in both emerging and developed market consumer discretionary equities have reached their lowest levels in over two years.

Our take

Central banks are justified in expressing hesitation about easing given the price risks, but we caution against expectations of constant demand elasticity. In other words, households are now in a different demand environment compared to the post-pandemic recovery phase. Given the uncertainty surrounding the global economy and long-term factors, such as AI, which could challenge the labor market, it is understandable for incremental earnings growth to be redirected to savings rather than spending.

Forward look

We expect holdings in consumer discretionary to remain weak. Given that the automotive industry is a key part of the sector and some of the structural, price-deflationary trends are continuing, it is difficult to justify re-rating. Fiscal stimulus in Europe is being concentrated in the defense sector (and fully reflected in equity holdings), while realized stimulus in APAC for now continues to focus on improved welfare provision or managing the cost of living, leaving limited space for discretionary income. Although savings levels are high, household debt ratios across much of Asia have increased in recent years, which will limit credit impulse. In the near term, we expect the household sectors to continue underperforming while flows remain concentrated in technology and industry.

Different valuations, similar reasons behind APAC and U.S. duration interest

EXHIBIT #3: MONTHLY SMOOTHED FLOW, GOVERNMENT BONDS WITH MATURITIES OF 10 YEARS OR GREATER

_{Source: BNY}

Cash interest across APAC is growing, but recently we have also seen a surge flow into duration. On a monthly smoothed basis, flows into government bonds with maturities of 10 years or greater have now surpassed U.S. flows, on a monthly smoothed basis. While this segment also outperformed in April, the risk environment was completely different as there has not been any forced deleveraging or shift into domestic bonds. Meanwhile, U.S. duration is also performing well despite fiscal concerns, helped by higher yields and a weaker dollar. Assuming U.S. fiscal dominance risks are now in the price, flows into APAC and U.S. duration point to a weak growth environment up ahead and sustained policy easing.

Our take

Recent reports suggesting the Bank of Japan will curtail the slowdown in bond purchases points to some calibration in quantitative easing. With yields at much more attractive levels, global participation is understandably higher. Meanwhile, China’s monetary policy expectations will also help anchor bond yields while additional supply to finance stimulus is still being planned. Consequently, we believe the inflows reflect weakness in the current growth environment, but the lack of a strong supply means cross-border investors are willing to take more duration risk. No “step-change” is anticipated along the lines of Germany’s change in fiscal stance to finance defense spending. European duration is struggling due to steepening in the U.K. and fiscal pressures in the Eurozone, but even in this region we can see that duration interest is picking up, which points to a softer growth picture despite central banks’ lack of room to cut rates.

Forward look

Both Japan and China have flagged household support this week, and we continue to take the view that APAC’s export-based economies need strong fiscal impulse to kickstart the rebalancing process in favor of consumer-based growth. Current duration flows in APAC and the U.S. point to weak growth, but if the former truly follows Germany in adopting a far more proactive fiscal approach, current flows – especially in EM APAC duration – risk being caught on the wrong end of material steepening. We believe there is a strong case for long-term gains in allocations in APAC debt, at the expense of the U.S. or other economies, but current flows are taking place at the wrong point in the cycle.

Bottom line

As we approach the end of the quarter, many flow themes are pointing to greater caution in asset allocation. Growth fears – led by household retrenchment – are pushing down allocations in consumer-related sectors whereas cash and duration flows are growing strongly again. The preference for APAC cash and duration is particularly worrying for global growth for the rest of the year, even with agreeable settlements on trade with the U.S.

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