Key Highlights

• JPY and CHF finding bids despite central bank caution
• Front-end USD cash preference surges, T-bill interest soft
• Energy flows recover but holdings remain very light

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Safety bids for low-yielders defy policy expectations

EXHIBIT #1: MONTHLY SMOOTHED FLOW, CHF AND JPY

_Source: BNY

Geopolitical risk has been at the forefront of market trends over the past week. The dollar and U.S. assets have broadly recovered their safety properties, but other “havens” are also benefiting. The JPY’s current flow averages, while far below the April highs, have improved notably ahead of the BoJ and Fed decisions. Meanwhile, the CHF is also approaching being net bought on a monthly smoothed basis, even though the Swiss National Bank (SNB) is widely expected to cut the benchmark rate to zero on Thursday and is definitely signaling that negative rates are on the way.

Our take

We note that the JPY and CHF are currently being net bought despite their respective central banks moving in the opposite direction. While not an outright easing step akin to the SNB, the Bank of Japan’s decision to slow its tapering of bond purchases has been well-flagged. Coupled with Governor Ueda’s refusal to countenance hikes in the near term, this represents a small step back from an outright hawkish approach. Taken together with the Fed’s current outlook, there is no support for these currencies based on policy differentials or hedging dynamics. Marginal demand is clearly coming from more intangible aspects, such as diversification of “safe assets,” even at a time when the dollar is performing well.

Forward look

We see a strong valuation case for both currencies to continue strengthening. Holdings are not stretched. In Japan, higher rates over the medium term will continue to favor the country’s financial account, and there is large enough of an asset base for domestic and cross-border investors to access. For the franc, based on the Bank of International Settlements’ (BIS) real effective exchange rate (REER) figures, the currency is not extremely overvalued relative to 2011 levels when very unorthodox policy was deployed. Inflation differentials will continue to anchor CHF valuations to the downside, and we suspect tolerance levels for further CHF gains are high.

Geopolitical risk reflected in USD cash demand, but T-bills struggle

EXHIBIT #2: MONTHLY CROSS-BORDER SMOOTHED FLOW, CASH AND SHORT-TERM INSTRUMENTS (CAST) AND T-BILLS

_{Source: BNY}

The most notable sign of geopolitics-specific risk aversion is clearly seen in the U.S. cash markets. Previously, flow interest was relatively neutral. The strongest period of cash interest was through end-April and early May. This was the period of recovery in risk appetite and Fed communication pointed to limited scope for rate cuts. T-bills initially benefited from risk and U.S. rate sensitivity during that period, but the “sovereign risk premium” may have exerted a greater impact on the same cash-driven flows. 

Our take

Cross-border investors are still happy to maintain and even increase their cash preference for the U.S., but there is now clear delineation between general liquidity management, which continues to favor instruments, such as money market paper or short-dated commercial paper. However, the lack of cross-border cash demand is of limited consequence to market structure and the dollar. Our data show that aggregate flows are comfortably in favor of purchases for T-bills, indicating U.S. home bias for short-dated assets is similarly strong, but fiscal premia is not an issue for front-end instruments.

Forward look

In the event of geopolitical conflagration, we continue to see the dollar performing well. History has shown that liquidity preference will rise sharply in the dollar’s favor and even cross-border T-bill interest will recover. Given the dollar’s valuations have softened of late, there is sufficient compensation for a short-term allocation shift despite long-term fundamental concerns. Furthermore, as the current tail risks largely center around a short-term energy spike, global concerns over stagflation will rise, somewhat negating the U.S.’ current struggles with the same risks. Over the long-term, home bias in U.S. Treasury securities will continue to rise, which is a natural extension of the current trade rebalancing process.

Energy bids are rising but with caution, structural demand a far bigger worry than supply disruptions

EXHIBIT #3: MONTHLY SMOOTHED EQUITY SECTOR FLOW, EM AND DM ENERGY COMPANIES

_{Source: BNY}

Even before recent events, we note that flows into global energy stocks had started to pick up. Developed market energy names saw interest recover through early May, but recently the leadership of inflows has been assumed by emerging market names. There is no rationale behind the divergence, as the tail risks surrounding the conflagration will have a global impact, either directly through supply or indirectly through prices. Either way, we believe the demand outlook will render such flows unsustainable.

Our take

The International Energy Agency (IEA) Oil 2025 report published yesterday is grim reading for energy companies. Forecasting supply and demand dynamics through 2030, the IEA warns that China’s consumption will peak as soon as 2027 and the global oil supply increase is “set to far outpace demand growth in coming years.” Regardless of supply disruption in the near term, the demand outlook is simply not strong enough to sustain previous multiples for energy companies.

Forward look

We expect energy-linked inflows to plateau soon, assuming the tail risks in the Middle East do not materialize. Our data also show that even with recent flows, the holdings gap between the energy sector and aggregate equity holdings globally remains at the year-to-date. The only point of convergence this year was around Liberation Day, when other high-performing sectors corrected aggressively. In other words, non-energy sectors are pricing in far stronger growth and investment demand compared to the energy sector. Any convergence will err towards de-rating in the highest-performing sectors and industries.

Bottom line

Across dollar cash, the yen and Swiss France, markets are adding to defensive postures. In the short-term, geopolitics will continue to drive flows. However, lofty valuations in equities despite growth concerns is likely contributing to higher general demand for havens. Despite the need to price in some fiscal or policy risk to the U.S. based on recent events, liquidity preference for the dollar remains strong across all classes of investors. Such preference could be challenged upon US-specific risk aversion episodes, but as for current events, traditional reaction functions broadly apply.

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