Key Highlights

• AUD seeks to benefit from Sino-U.S. necessities
• CEE FX looks to stabilize holdings as NBP and CNB meet
• BoE unlikely to get a pre-budget cut over the line before the Autumn Budget

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AUD exposures neutral as equity interest surges

EXHIBIT #1: NET AUD EXPOSURE, ASSUMING 70–30 FIXED INCOME/EQUITY AUSTRALIA PORTFOLIO

_Source: BNY

Our take

Many of the agreements signed over the last few days in APAC highlight the strong desire for countries in the region to retain strategic autonomy. Geography will always tie Asia to China, but the U.S. market and access to its current tech prowess is also essential for growth and development. Consequently, countries which can maintain strong economic links to both without any clear sign of geostrategic alignment will find strong market favor. All leaders attending the APEC and ASEAN summits will likely hope for de-escalation after the Xi-Trump summit, but some countries are probably better positioned than others to mitigate any impact in the event of a more adverse outcome.

Australia, for example, is in the unique position of leveraging its rich natural resources holdings and mining expertise to boost its own resilience. To be clear, Australia’s resource exports to China continues to face headwinds: the decline iron ore demand as China moves away from real estate-based growth has clearly affected Australia’s terms of trade and AUD valuations. There has been a knock-on impact on Australian coking exports as well, and China’s renewables prowess will dampen thermal coal exports over time. However, with iron ore, natural gas and coal exports to China accounting for more than a fifth of Australia’s total goods exports alone in 2024 (A$138bn vs. A$644bn), the bilateral trade relationship will remain crucial to the Australian economy.

Forward Look

More recently, rare earths have moved up the agenda and may breathe new life into Australia’s mining industry – a theme which is clearly contributing to performance in Australian equities. Defense arrangements aside, the U.S. is now looking to leverage Australian expertise – home of the world’s largest rare earths producer outside of China – in mining and refining in an effort to boost its own supply chain resilience. A recent National University of Singapore paper highlighted that U.S. and Australian heavy rare earth element (HREE) deposits are commercially unviable, but with “sufficient price support (i.e., 5–10x China prices) and long-term offtake agreements, some of these projects could be commercially viable.” The implied level of government investment/subsidies could surge as a result and if much of the investment is from overseas, the implications for Australia’s terms of trade could be profound, especially through productivity channels, as even at 10x Chinese prices the global rare earths trade is comparatively small. iFlow currently indicates that net exposure to AUD is flat and in line with the 2-year average (Exhibit #1), despite the sharp rise in Australian equity holdings by cross-border investors in recent months (nearly 30% since May) based on the rare-earths theme. Australian government bonds are currently only 4% above the rolling 12-month holdings average (vs. 9% above in equities). The November 4th RBA decision may be too early for such a signal, but if a new kind of investment cycle is approaching for Australia, then AUD should look at re-rating – and that is even before the anticipated increase in hedge ratios on overseas investments by the superannuation community.

CEE looking vulnerable again but may find month-end relief

EXHIBIT #2: CEE FX HOLDINGS VS. TOTAL EM FX HOLDINGS

_{Source: BNY}

Our take

Our month-end rebalancing analysis indicates that most high-carry currencies are due for a breather, apart from South Africa. CEE currencies like HUF and PLN will also be hoping for some relief, as these currencies have borne the brunt of the carry unwind in the region. We had been anticipating such a reduction in holdings due to the high level of asset holdings, but the somewhat earlier than anticipated shift in policy easing had added to such pressures. Meanwhile, iFlow indicates that CEE FX is now materially underheld relative to the rest of EM (Exhibit #2). Although the extent of underheld positioning was even stronger in June, the drivers were very different at the time as hedging was solely due to election-related political risk. The driver now is the transition of central bank cycles to a new phase, so there is less of a binary aspect which could encourage a speedy reversal.

Forward look

We doubt asset allocators will hold CEE FX to the same standard as larger EM names with higher nominal/real yields with more liquid capital markets. However, as yields move toward more normal levels, we do think CEE central banks will need to focus more on currency stability. For example, Bank Indonesia surprised last week by holding rates with a view to currency stability and reserve coverage, and central banks remain active in FX markets. The biggest difference is that the ECB looks unlikely to move for the rest of the year, whereas the Fed has ample space, so the policy gap for the rest of EM is far more comfortable compared to CEE. If rebalancing fails to support the region’s currencies heading into next week’s NBP and CNB meetings, we would lean against more dovish pricing as asset liquidation from high holdings level could be the next risk.

HM Treasury needs to look at itself for rate relief from the BoE

EXHIBIT #3: PUBLIC SECTOR BORROWING OUTTURNS VS. FORECAST

_Source: BNY

Our take

The U.K.’s September CPI result would have come as some relief to the Bank of England but we do not believe the votes are there for a cut at their November meeting. Current pricing remains cautious and we sympathize with MPC member Mann’s view that the U.K. faces “persistently persistent” inflation, with sustained restrictiveness required to anchor expectations. The most positive assessment for policy from the September inflation print is that upside risks to price growth may have eased, but with services inflation running at 4.7% y/y and total wage growth at 5.0% y/y, for September, there remains very limited relief on the wage front. The September wage report in particular notes a very uncomfortable split in drivers as private sector earnings have fallen to 4.4% y/y – the lowest in nearly four years. The Treasury will be hoping for some rate relief from the Bank of England ahead of the end-November budget, but the government may also need to recognize that its own fiscal distribution is preventing such relief from being realized.

Forward look

For developed-market economies facing stagflation, we repeatedly cite ECB President Lagarde’s 2023 Sintra speech, when she warned that since the pandemic the public and services sectors have seen the highest levels of employment growth but productivity growth weakness (and outright declines in the public sector’s case). The Bank of England also believes that the last round of tax rises also contributed to inflation impulse, which is another outcome the government will need to avoid with highly anticipated tax rises in its latest budget. The latest borrowing figures continue to point to an overshoot (Exhibit #3) in borrowing requirements and we believe the only way to avoid an adverse gilt market reaction is for some commitment to spending cuts as productivity gains in the public sectors are hard to measure and realize. The bottom line is that for the Bank of England to help the Treasury with lower rates and a more favorable gilt yield curve, the Treasury must look within and help itself first.

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