Key Highlights

• With risk mood changing, rebalancing pressure will be the next key determinant of whether trends extend
• The focus this week will be on U.S. and Japanese bond sales, market tenderness, global growth and central bank decisions
• Trade discussions and other policy shifts will keep the focus on the dollar and U.S. yields

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What you need to know

The focus last week was more on politics than economics, starting with the surprise Romania election result, continuing with the Trump-Putin call, and ending with the G7 meeting of finance ministers supporting trade deals. The main economic data came from flash PMI reports showing surprising U.S. growth and EU weakness. Central bankers cut rates in Australia and Indonesia, while the BoE and Fedspeakers were hawkish. Bonds were at the center of volatility this week, following the Moody’s downgrade of U.S. government debt. But Monday was a nonevent, as investors bought the dip in both bonds and stocks. This should have led markets to watch FX for reversals to match the May bounce-back in equities. However, if there was one clear trend last week it was dollar weakness, with the index off 1.7% to 99.45 from 101.09 last week. The downgrade of U.S. debt, the passage by the House of a budget bill and ongoing pushback by Fedspeakers on rate cuts all made it clear that higher yields are not enough to support the dollar, even as the carry trade is in full bloom in other places, with Brazil and South Africa leading the way. The other notable divergence came in equities, with APAC and EMEA seeing a sixth straight week of gains. Taiwan and Poland led in our flows, while U.S. markets were lower. The next week may see a return to rebalancing strategies and risks, with volatility across markets remaining high and serving as a potential brake on those chasing trends.

The gray swans of U.S. policy are becoming clearer

_{EXHIBIT #1: U.S. POLICY AFFECTS GDP AND INFLATION} 

_{Source: BNY, Tax Foundation, Bloomberg}

Our take: Trump’s policy shifts have dominated markets since January 21. While uncertainty about the order, size and scope of the changes was key for Q1, the details have become clearer in Q2. With just a few weeks left until quarter-end, clarity about how policy is shifting will be important for how investors think about growth and inflation. And the week ahead will provide more clarity, as tariffs talks with the EU, Japan and China progress, peace talks continue between Russia and Ukraine, and the Senate debates the budget bill passed by the House. In Exhibit #1 we show the consensus forecasts for Trump policy shifts on tariffs, taxes, deportations, DOGE, deregulation and the dollar. The error forecast size is significant, and the dots do not accurately reflect the inherent uncertainty. While the magnitude of these shifts for the U.S. economy and their full impact is still unknown, the black swan nature (tail risks) of these events is becoming more defined. This leaves a nonlinear trend, suggesting a smile for potential growth in the year ahead. Investors have been paying attention, and our flows reflect this, with bond buying at home and equity inflows but dollar weakness as a result of cross-border hedging.

Forward look: In the week ahead, any events that alter views of global inflation and growth will be important. Friday showed that tariff risks are still in play for the EU as well as certain sectors like smart phones. Investors are keen to end Q2 on a good note, and this makes the usual month-end data all the more important, with the focus in the U.S. on durable goods and negotiations, in Asia on growth, and in Europe on inflation. In FX, month-end rebalancing is expected to help SEK, JPY and USD, and hurt GBP,  ZAR, BRL and INR. For bonds, the Treasury supply of $183bn in coupons will matter along with how bills price the X-Date risks ahead. The Japan 40y auction will be important as well, and there will be a focus globally on the yield curve steepening trade. In equities, the focus will continue to be on tariff risks, with the EU overheld and the U.S. underheld.

What we're watching

U.S. focus on FOMC minutes, durable goods and consumer confidence

_{Source: BNY, Bloomberg}

Last week was light in terms of data, and the upcoming holiday-shortened week won’t offer much more information on the economy. The biggest fear came from Canada CPI and growth data as a foreshadowing for U.S. risks ahead. So far, we haven’t seen a marked deterioration in hard data on the U.S. economy and the coming week isn’t likely to show much in this regard either.

Our take: There are a few events in the U.S. worth keeping an eye out for – namely three separate coupon auctions: $69bn in 2y notes, $70bn in 5y notes, and $44bn in 7y notes. Given the sharp focus on the bond market and yields, the performance of these offerings could make a difference. The minutes of the May 7 FOMC meeting will be released on May 28, and although they’re somewhat stale, they could offer insights into the debate within the central bank on monetary policy during a time of great uncertainty.

Forward look: In Canada, the policy and economic data have left our view muddied, which won't likely change in the week ahead given the dearth of data, but we will get the Canadian SEPH report, essentially the establishment employment survey. We have been rather dovish when talking about Bank of Canada policy, but the sticky core inflation data from last week gives us pause. There are fewer than two full rate cuts currently priced into the Canadian curve, but a weaker employment number – which could be on the cards – might bring another cut forward into the pricing.

Bad news may just be good news for Germany and the Eurozone

_{EXHIBIT #3: SHARP DIVERGENCE BETWEEN CROSS-BORDER FLOWS OF U.K. GILTS AND GERMAN BUNDS}

_Source: BNY

Our take: The state of bond markets will remain in focus in EMEA, but this is one area where Germany and the rest of the Eurozone may just outperform. As policymakers have feared, survey data and other leading indicators for Germany in May are beginning to disappoint to the downside, with consumer weakness emerging as an increasingly pressing concern – for two straight months it is the services PMI which has undermined the composite print. Initial worries about manufacturing and export performance following “Liberation Day” now appear somewhat overstated; instead, the more significant issue lies in the sharp deterioration in household sentiment. However, if household demand weakens further, placing downward pressure on both inflation and inflation expectations, this could ultimately serve as a blessing in disguise.

The current market is far more concerned about stagflation across developed economies. Supply problems in labor markets are a particular focus. For example, the U.K.’s very high inactivity rate is being cited as one of the reasons behind high core inflation and leading to entrenched wage and inflation expectations. Poor productivity in the services sector had also been a source of inflation strength across the Eurozone, but with clear signs of such pressures easing, the ECB would have more room to act to ease financial conditions. Crucially, sustained demand-based disinflation is very conducive to keeping real rates high and supporting inflows into duration. Germany already enjoys a ratings advantage, and now the real yield advantage is starting to show. In contrast the U.K. is struggling materially (Exhibit #3).

Forward look: We remain concerned about the euro’s current valuation, particularly as its strength appears disproportionate to the relatively low level of holdings in industrial equities – assets that are highly sensitive to the effect of earnings on translation effects. However, should disinflation accelerate, the euro’s real effective exchange rate could stabilize or even decline due to favorable inflation differentials, especially as inflation concerns are now shifting to the upside in the U.S., the U.K., Japan and other key trade partners. This pathway, while not ideal for household incomes, may provide the competitiveness boost the EU has long sought and could help rebalance euro valuations more sustainably. To be clear, we do not view this as a constructive narrative; fiscal stimulus remains the more credible route to strengthening competitiveness, productivity and incomes. Nonetheless, with stagflation risks rising, softer data that apply downward pressure on prices could be welcome in the short term – helping to limit financial stress and reduce bear steepening in government bond curves.

APAC: South Korea Business Sentiment, India GDP and BoK and RBNZ meetings

_{EXHIBIT #4: LACK OF DIRECTION IN SOUTH KOREA BUSINESS SENTIMENT IN 2025}

_{Source: BNY, Korea Statistics}

Our take: In the Asia-Pacific region, the focus this week will be on South Korea, including the May composite business survey index, consumer confidence and inflation expectations, and the April cyclical leading index. Elsewhere, Thailand and the Philippines will release April trade data and Taiwan and India will provide Q1 GDP.  China data will be limited to April industrial profits before May PMI releases next week.

The South Korea May Composite Business Survey Index (BSI) and inflation expectations in consumer confidence releases will be closely watched. We will see if South Korean business sentiment, which had been broadly directionless, will finally gain upside momentum on the back of a sharp recovery of asset prices and the positive trade negotiation process, or remain under pressure by persistently sluggish domestic growth momentum and ongoing political turmoil. There is, however, a glimmer of hope with the turnaround of the leading indicator in March after a persistent downtrend since March 2024. A further uptick in April’s leading indicators might just be sufficient for South Korea to avoid a technical recession after a -0.2% quarterly contraction in Q1 2025.

APAC export growth in April was better than expected, due in part to front-loading activities. Similar strength can also be seen in April trade data this week for Thailand and the Philippines. India’s Q1 GDP is seen as gaining momentum, coming in at 6.8% after having bottomed at 5.6% y/y in Q3 2024. The growth recovery should not deter the Reserve Bank of India from easing rates at its June policy meeting, given the fast deceleration of inflationary pressure. India’s April inflation stood at 3.2% y/y, the lowest level since July 2019.

Lastly, Australia’s April inflation and trimmed mean inflation are susceptible to downside risk following the sizeable downward revision of GDP and the inflation forecast in the latest Statement of Monetary Policy. Australia’s H1 and H2 2025 CPI were lowered to 2.1% y/y and 3.0% y/y from 2.4% y/y and 3.7% y/y, respectively, while trimmed mean inflation was lowered by 0.1 percentage points to 2.6% over the same period.

In monetary policy, the Reserve Bank of New Zealand is expected to cut rates by 25bp to 3.25%, the sixth consecutive rate cut in the current easing cycle, while the Bank of Korea is expected to cut rates by 25bp to 2.50% and revise its GDP growth forecast down, currently at 1.5% and 1.8% for 2025 and 2026 respectively.

Forward look: We are constructive for Asia risk with improving market sentiment. Near-term regional policy easing is supportive for equities and fixed income. As for foreign exchange, the USD weakening path is likely to overshadow the negative impact on FX of the narrowing interest rate differential. Further supporting regional risks is the turnaround of capital flows after selling pressure from the beginning of the year. With the renewed carry momentum, low-yielding funding currencies are expected to be at a disadvantage against higher-yielding currencies. 

Bottom line

Changing risk appetites and rebalancing pressures are key to extending current trends, with the week ahead focused on bond sales in the U.S. and Japan, market sensitivity, global growth and central bank decisions. The coming week may see a return to rebalancing strategies and risks reduction, with ongoing high market volatility potentially hindering trend-following. President Trump’s threat to impose tariffs of 50% on the EU on June 1 could be the next hurdle for uncertainty in dealmaking. We see risks in bonds as ongoing, USD weakness extending and stocks unlikely to break out further to the upside. FOMC minutes and the bias to wait for data may shift if financial conditions return as a concern. Trade discussions and policy shifts continue to influence the USD and U.S., both of which will constrain equity markets. We are likely to end the month less sanguine than we started.

Calendar for May 26-30

Central bank decisions

Israel, BoI (Monday, May 26) – The Bank of Israel is expected to hold its benchmark interest rate at 4.5% on May 26, as April inflation surprised to the upside at 3.6% y/y, keeping it above the central bank’s 1-3% target range. Markets have priced out near-term easing, though expectations remain for two cuts later in 2025. Q1 GDP rebounded sharply, growing at a 3.4% annualized pace after a contraction in Q4, signaling resilience in economic activity. The shekel has stabilized and inflation expectations for the next year are now anchored below 2%. However, policymakers are likely to remain cautious, opting for a steady policy rate until clearer disinflation signals emerge, in line with global central banks delaying rate cuts. iFlow indicates the emergence of some recovery flow into local government bonds as opposed to equities, but overall holdings are weak in duration due to consistent selling year to date.

Hungary, MNB (Tuesday, May 27) – The National Bank of Hungary is expected to maintain its base rate at 6.5% on May 27, marking the eighth consecutive hold. April inflation eased to 4.2% y/y, down from 4.8% in March, but it remains above the 3% target. Despite subdued economic growth – projected at below 2% this year – the central bank is likely to keep policy tight, with markets anticipating only a minor rate reduction to 6.25% by year-end. CEE is not at the forefront of duration or carry flows due to the state of the policy cycle, but improvement in yield demand (where fiscal policy is credible) can support HUF holdings.

New Zealand, RBNZ (Wednesday, May 28) – The Reserve Bank of New Zealand is widely expected to cut the official cash rate (OCR) by 25bp to 3.5% at its May 28 meeting, following a similar cut in April. This move aims to support the economy amid weak consumer demand and a downgraded GDP growth forecast of 2.9% for the year ending June 2026. Inflation expectations have risen slightly, with one-year-ahead CPI expectations increasing to 2.41%. Markets anticipate further easing, with the OCR projected to decline to 2.91% by March 2026. Recent NZD performance has been poor and hedge levels remain high based on iFlow cross-border holdings. Until RBNZ signals a pause the currency may struggle for traction.

South Korea, Bank of Korea (Thursday, May 29) - The Bank of Korea (BoK) is expected to cut rates by 25bp to 2.50%, with a downward revision of its GDP forecast. BoK’s current macroeconomic forecast projects GDP growth of 1.5% for 2025 and 1.8% for 2026. Positive market sentiment and a weaker USD trend should allow the BoK to implement the cut with minimal concern about renewed KRW depreciation. The cut is deemed necessary to boost market confidence, alongside government fiscal measures. Beyond the immediate policy decision, market attention will shift to the June 3 presidential election and ongoing trade negotiations with the U.S., both representing critical factors for South Korea’s economic outlook.

South Africa, SARB (Thursday, May 29) – The South African Reserve Bank is expected to cut the repo rate to 7.25%. Even though April inflation edged up to 2.8% it remains below the 3-6% target range. FRA pricing supports easing expectations but given the current environment there is a compelling case for a hold as well, with potential cuts later in the year. The central bank is likely to maintain a cautious stance amid global uncertainties and domestic fiscal challenges. However, the market has retained confidence regarding the budgetary outlook and the more assertive inflation target from SARB, which combined can prove supportive for real rates and duration flows, which reversed again this week after a good run since the end of April, according to iFlow.

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