Key Highlights

• RBA decision solidifies funding status of APAC FX
• APAC equity flows reach year-to-date high as tech leads the way
• Duration unperturbed by lower ratings and yields

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Most APAC currencies now underheld/neutral and facing further outflows

EXHIBIT #1: EM AND DM CURRENCIES WEEKLY SCORED FLOW VS. HOLDINGS

_Source: BNY

Even before this week’s RBA decision, iFlow data from the past week indicated that markets were adding to their underheld positions. The majority of currencies in the region were facing sales and moving further into an underheld position. Exhibit #1 shows the asymmetry within the region, as the “median position” for underheld currencies is clearly a case of underheld currencies facing further sales, but overheld currencies are now barely moving. Evidently, momentum is gaining to use APAC currencies as funders, or simply as additional hedging to reflect widening rate differentials.

Our take

The surprisingly dovish decision from the Reserve Bank of Australia (RBA), complemented by clear additional monetary and easing intent from Beijing, indicates that financial conditions will loosen further in the region. While the RBA stressed the need for caution, it appears that the central bank continues to take the most conservative view possible on the impact of trade tensions and is acting accordingly. We believe this is somewhat excessive as China has reached some form of understanding with the U.S., while the latest reports suggest that Japan will give some ground. This means that policy stances in the region are too loose relative to fundamentals.

Forward look

As long as the Fed continues to anchor U.S. front-end rates and there is no additional deterioration in trade relations from what is already a very weak base, risk appetite in Asia should stabilize, especially as the focus shifts toward stronger fiscal impulse, which most APAC economies can afford. The past few weeks of FX carry recovery have been led by Europe, but now that APAC central banks seek to take the lead in easing, we expect material rotation of funding interest into APAC.

EM APAC equity interest reaching highest levels year-to-date, led by technology interest

EXHIBIT #2: COMMUNICATION SERVICES AND IT SECTORAL FLOW, EM APAC

_{Source: BNY}

Any excessive loosening in financial conditions is seen as positive for equities, and cross-border flows into APAC equity markets have responded in kind. On a weekly smoothed basis, our data show that APAC equities have recently had their best week year to date, with buying interest led by the technology segment as Information Technology and Communication Services lead inflows. The latter’s recovery has been particularly important for wider flows in the region, as key Chinese names in this sector offer broader access to international clients and will benefit from marginal rotational flow from the U.S. The performance of Information Technology has been more consistent, led by secular flows into the semiconductor industry.

Our take

As European valuations begin to struggle at their highs and a deal with the U.S. remains elusive, we expect APAC to increasingly benefit from asset rotation flows. Some could be reflecting stronger local bias due to concerns about the erosion of U.S. exceptionalism, but there is also an opportunity for APAC to make its own case for earnings growth and re-rating. Loose financial conditions through rates and the currency do provide an advantage, though we expect some degree of caution on the latter as reports suggest FX policies are seen as non-tariff barriers which the U.S. seeks to address in trade negotiations.

Forward look

On a holdings basis, APAC continues to lag behind EMEA materially and we believe fiscal impulse is the missing element. Well before trade tensions escalated, markets were looking for renewed support to boost domestic consumption. The risk remains that easing of trade tensions will obviate the need for stronger household-based stimulus in North Asia, and there isn’t the equivalent of a shift in the continent’s defense/security mindset which is currently anchoring fiscal expectations in Europe. However, recent comments from Chinese President Xi Jinping points to greater prioritization of employment growth, and there is consensus across regional economies that monetary stimulus alone will not be enough to shift expectations – future performance of communication services in the region will depend on government support for household cashflow in the coming months.

U.S. and APAC still leading duration interest

EXHIBIT #3: FLOWS INTO U.S., EUROPEAN AND APAC SOVEREIGN BONDS, MATURITIES OF 10 YEARS OR GREATER

_{Source: BNY}

The recent downgrade of U.S. debt has put fiscal dominance back on the radar. We do not see any major issues in developed market sovereign bonds in the near term and general monetary easing is helping the market absorb issuance. Outliers such as Japan will experience greater volatility, but the country’s savings base can step in to limit any fallout. Our flows suggest that momentum is starting to struggle in Europe, judging by demand in the sovereign space with maturities of 10 years and above.

Our take

We are less concerned about term premia in the Eurozone (the U.K. is a different story) but supply is starting to affect sentiment. The latest data suggest that total public syndications have hit €1tn in the quickest time ever. If it had not been for a period of stasis around “Liberation Day,” the milestone would have been reached in early May, whereas the previous record was May 29. Higher German yields from re-rating of trend growth have supported yields while spreads are well-behaved. Marginal decline in demand for U.S. investment grade paper (a trend iFlow confirms) is also supporting greater home bias. 

Forward look

Similar to the case we make for European equities, the change in sentiment for the EU and Eurozone is now very well priced and the market will now look for Europe to deliver on investment, competitiveness and productivity promises, lest term premia re-emerge, with a knock-on impact on spreads. The U.K.-EU relationship reset is also conducive to general competitiveness on the margins, but markets will look for issuance to complement corporate resilience as export challenges remain. Meanwhile, cheaper dollar valuations and much more assertive easing by APAC will start to make duration more attractive elsewhere, and Europe cannot expect demand to remain as resilient in H2.

Bottom Line

Regional- and asset-level preferences are becoming clear, and flows are obviously being attracted to favorable positioning and downward pressure on financial conditions. Overall, we still see flows into APAC equities with high levels of FX hedging as offering the best risk-reward. As trade tensions take a back seat, fiscal credibility will move up the agenda. In the coming weeks, the focus will remain on the sustainability of U.S. debt as budget plans move forward. However, markets should not discount the risk of APAC and European “under-delivering” on growth due to poor fiscal execution, to the detriment of elevated holdings in local equities and bonds.

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