Key Highlights

• Commodity-backed names leading in G10 cross-border FX flow.
• ASEAN equities diverge as exporters struggle to balance relations with the U.S. and China.
• Cash preference growing irrespective of yield and fiscal status.

The ongoing impact of USD value erosion

EXHIBIT #1: WEEKLY AVERAGED CROSS-BORDER FLOW (AS OF APRIL 21), G10 FX – 4 OF 5 LEADERS ARE COMMODITY-BASED

_{Source: BNY}

FX markets remain volatile, but asset allocators have interpreted the ongoing surge in gold prices as a sign that the dollar continues to face valuation erosion. In developed market cross-border FX flow, we believe a similar dynamic is starting to arise as markets look for ways to express a view on real value erosion. Over the past week as the debate escalated over monetary policy independence in the U.S., we can see that four out of the top five performers in G10 FX were commodity-based currencies, none of which have benchmark policy rates higher than the U.S.

Our take

These markets are not liquid enough to generate very strong inflows into bonds and our data – based on cross-border investor flow – reflect adjustments in hedges. On the one hand, ongoing selling in underlying markets could lead to a rise in hedge removals. On the other hand, if asset flows are limited but hedges are also being removed, or not being rolled, it could reflect a decline in dollar preference.

Forward look

Sustained reduction in hedges by U.S. or USD-based investors on their overseas assets, without any currency benefit, could be an indication of rising concern over the dollar’s role in value preservation. This is symptomatic of broader stagflation fears over the U.S. economy, which is forcing flows into assets that provide real protection. While we do not expect a meaningful recovery in global commodity demand, this does not preclude price gains in dollar terms due to revaluation of the dollar’s purchasing power, in turn helping terms of trade for commodity currencies.

ASEAN attitudes toward the U.S. harden

EXHIBIT #2: SCORED HOLDINGS FOR THAI, MALAY AND SINGAPOREAN EQUITIES

_Source:BNY

Since April, Singaporean equity market holdings have started to outperform key ASEAN peers such as Malaysia and Thailand for the first time this year. Even now, scored holdings of Singaporean equities remain above the 1-year average, underscoring the economy’s status as a relative safe haven. The country has managed to avoid large reciprocal tariffs from the U.S., while its export mix to the U.S. is higher up the value-added chain and incorporates a significant re-export component. Singapore is the only ASEAN economy with a meaningful services trade surplus, which will show more limited sensitivity to current global trade tensions.

Our take

China’s focus on trade over the past week has shifted toward regional partners. President Xi Jinping’s trip to three ASEAN nations last week underscored Beijing’s outreach. However, more recent warnings against countries reaching deals with the U.S. to China’s detriment underscores the delicate balancing act that ASEAN economies currently face. There is no clear path forward at present and the region risks antagonizing both. Consequently, the impact is being felt in developing ASEAN economies with heavy exposures to low value-added exports to the U.S., while serving as destinations for Chinese investment. In contrast, Singapore is benefitting from its diversified sources of balance of payments and continues to serve as region’s safe haven across multiple asset classes.

Forward look

We are seeing early signs of a hardening of ASEAN attitudes against the U.S. due to the lack of initial progress on trade details. Consequently, volatility is likely to remain if agreements remain elusive ahead of the expiration of the tariff postponement period. We expect the region’s assets to continue to trade heavily. The prospect of ongoing asset outflows will require tight FX management by the region’s central banks.

Shifting valuations benefit U.K., Japan

EXHIBIT #3: CASH DEMAND SURGES IN JAPAN AND THE U.K.

_{Source:Bloomberg, BNY}

In another sign of growing risk aversion, our data show that cross-border flows into cash and short-term instruments (CAST) surged across developed market economies. The U.K., U.S., Japan, Canada and the Eurozone were the best-bought markets on a weekly scored flow basis – and these are generally the most liquid cash markets available for cash rotation. While the U.K. and the U.S. do offer good yields prospects, we note that the interest in Japanese, Eurozone and Swedish securities also points to a greater focus on liquidity rather than yields alone.

Our take

During extreme risk-off periods when cash/liquidity preference rises sharply, yield considerations are almost an afterthought. The recent increase in Bank of England rate cut expectations has not damaged cash interest, though the starting point is relatively favourable for the U.K. due to the high BoE base rate. Similar to the US, the long end of the U.K. curve has faced strong scrutiny, but this has not translated into reallocation flows either. If anything, GBP’s current strength points to marginal diversification benefits for the U.K. Meanwhile, given the level of JPY cash yields, there was very little incentive to add to Japanese cash instruments based on rates alone. 

Forward look

Risk aversion normally generates higher cash preference, but mostly in the dollar’s favour. Cross-border investors were happy to move straight into dollar cash, especially with high nominal rates. However, such preferences are clearly changing. Concerns over dollar valuations and greater home bias in asset allocation is causing changes in cash behaviour, with all core G7 cash markets benefitting from sustained risk aversion. Cash rotation will have a direct FX impact, further hurting the dollar’s outlook. GBP, EUR and JPY will benefit based on size and liquidity in cash instruments.

Bottom Line

We continue to urge caution regarding the dollar’s reserve status and general preference and believe some of the relevant concerns are overdone. However, events over the past week regarding the Fed’s independence would not be seen as helpful in this case. Flows into gold, commodity FX and overseas cash equivalents all speak to a diversification story on the front end to protect real value, despite the U.S. continuing to enjoy a nominal yield advantage. Upside inflation surprises in the U.S., which lowers real yields, could accelerate this process. Consequently, the market is right to fear the Fed may step back from its inflation focus prematurely.