Key Highlights

• USDJPY emerging as a hedge against Japanese fiscal risks
• Gold propels mining stocks globally, but South Africa clearly ahead
• EUR-based accounts more attentive to risks in OAT markets

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FX: USDJPY purchases becoming more active than JPY aggregate

EXHIBIT #1: JPY AGGREGATE FLOW (INVERTED) VS. USDJPY, AND GAP

_Source: BNY

Our take

Government formation talks are ongoing in Japan, but incoming Prime Minister Takaichi has moved fast to reassure markets that fiscal policy will be responsible, and we acknowledge that the new LDP leadership is unlikely to pursue strategies which would jeopardize credibility. Nonetheless, our data indicate that cross-border investors are erring on the side of caution for now, mostly because the JPY has entered this period of political uncertainty after a very strong period of purchases over the summer (Exhibit #1). We believe that these positions were established with JPY valuations and the prospect of additional BoJ hikes in mind, both of which are now in doubt. USDJPY has traditionally been a material driver of JPY in both directions, but a wide gap emerged during that run, where USDJPY was not as strongly sold compared to total JPY buying. As of early October, our data indicate that clients have turned net buyers of USDJPY on a monthly smoothed basis for the first time since late July, but JPY remains in light net bought territory by the same measure, which points to ongoing purchases (or a lack of sales) of JPY on the crosses. This indicates that cross-border investors are now broadly using USDJPY as a tool to hedge against Japan-specific risk, rather than simply reflecting Fed-BoJ rate differentials as in the past.

Forward look

USDJPY will likely stay bid in the meantime until the new government’s fiscal track is clear, but we shouldn’t totally discount rate factors either. Depending on how the U.S. shutdown evolves, the market is not pushing for pricing of Fed easing to move beyond what was reflected in the September Fed rate move. Furthermore, some of Takaichi’s allies have already called for the BoJ to proceed with caution. For example, Takaichi’s economic advisor Etsuro Honda said that an October move would be difficult. If realized, this means that September may have marked the widest point of divergence as well between a supposedly dovish Fed and the BoJ, whereas previously the BoJ was in a more assertive position than the ECB and BoE. On the other hand, if U.S. developments lead to greater Fed caution, cross-JPY purchases may find favor to hedge against any fiscal risk in Japan.

Equities: Metals and mining continue to strengthen holdings

EXHIBIT #2: REGIONAL METALS AND MINING INDUSTRY (GICS L3) EQUITY HOLDINGS

_Source: BNY

Our take

Gold’s performance this year has solidified its status as a diversification asset against “debasement.” As markets remain nervous regarding fiscal trajectories globally, the yellow metal’s weighting in strategic allocation has clearly increased, but also generated re-pricing in associated economies and companies. For most major developed and emerging markets, gold as a share of commodity production is not strong enough to shift any economy’s terms of trade materially, but the profitability and margins of mining companies and specialist producers have seen clear re-rating. Other “real assets” may also see price support in sympathy with the “debasement” trade, further supporting the metals and mining industry even though demand-based price gains remain elusive. Our data indicate that globally total holdings in the metals and mining industry (Exhibit #2, GICS L3) is now at 35% above the rolling 1-year average and all regions are benefiting strongly. However, the best performer is EM EMEA at over 45% above the rolling 1-year average. Given the lack of direct mining exposures in Central and Eastern Europe and Turkey, the biggest beneficiary is South Africa: close to 30% of the weighting of the Johannesburg Stock Exchange is in the “base resources.” South Africa was also the best-bought equity market in iFlow over the past week. In the Americas, the industry is rallying strongly, though we believe the U.S.’ focus on supply chain resilience rather than monetary factors is behind much of the gain.

Forward look

The lack of U.S. data at present is complicating policy pricing but the market continues to see easier financial conditions as the path of least resistance: the longer the U.S. shutdown, the bigger the likely economic impact which would trigger a policy response, especially if the labor market is adversely affected. In the near term, we acknowledge that such a path will continue to support gold and “real assets,” but the breadth of assets benefiting may need to expand. We have long expressed reservations regarding the current level of holdings in all assets in South Africa, for example. Much stronger terms of trade will lead to faster alignment with SARB’s inflation target and more aggressive easing, which requires greater hedging in the currency, even if equities and duration continue to perform.

Fixed income: Local accounts always less patient in OAT market

EXHIBIT #3: MONTHLY SMOOTHED FLOW INTO OATS, EUR-BASED VS. NON-EUR-BASED ACCOUNTS

_Source: BNY

Our take

The market will have a better sense of the way forward for France today as outgoing Prime Minister Lecornu wraps up his talks with political parties to ensure a viable path forward. The market appears to be in wait-and-see mode, but there are clear signs that the status quo is increasingly untenable – key opposition figures have already refused talks and called for the dissolution of parliament. If new parliamentary elections are the only path forward, the prospect of populist forces further improving their standing will likely add to current risk premia in the euro and more importantly the OAT market. Any cross-asset response akin to last June/July would be significant and place further pressure on the OAT–Bund spread, which currently stands at just below 90bp, a level which is uncomfortable but far from the threshold which would warrant even a discussion of intervention by the European Central Bank (ECB).

However, our data indicate that investors are starting to turn cautious, especially after a strong round of purchases through the summer despite the evident signs that former Prime Minister Bayrou’s tenure was likely to end. EUR-based accounts, largely dominated by Eurozone-based investors, started moderating flows toward the end of August and selling appears to have accelerated. In contrast, non-EUR accounts where cross-border investors dominate, have been slower to respond. This is not new: Exhibit #3 shows that throughout the political turbulence between mid-2024 and the end of Prime Minister Barnier’s tenure in Q4, EUR-based accounts were far more active throughout. It was not until early 2025 when non-EUR accounts really moved toward stronger OAT liquidation, at which point the market had shifted to other drivers.

Forward look

Non-EUR based accounts have shifted toward removing OAT exposures as well but the gap with EUR-based accounts has widened to November 2024 levels. This means that cross-border investors risk materially “over-owning” OATs relative to local investors. If the political situation deteriorates and local buyers are cautious, positioning reduction can only take place at a significant discount and there will likely be a knock-on impact on the EUR as well in response to such risks. We note that at the end of last year, cross-border hedges of the EUR also aggressively increased to around 2.4 times the rolling 1-year average, and the OAT–Bund spread approached 90bp. Lower ECB policy rates means the “starting point” for Eurozone financial conditions is more manageable, but current circumstances are a timely reminder that there will be other non-data factors which could disturb the ECB’s “good place.”

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