iFlow > Investor Trends
Appearing every Wednesday, Investor Trends provides a deep dive into patterns and behaviors in equity, bond and currency markets around the globe, underpinned with deeper macro insights.
Geoff Yu
Time to Read: 4 minutes
EXHIBIT #1: MONTHLY AVERAGE EM FX HOLDINGS AND PROFITABILITY
Source: BNY iFlow
Our take
The U.S. is set to avoid an extended shutdown towards year-end but there are still signs that risk appetite is struggling to catch up. This is still an equity-driven narrative. For now, it appears that risk exposures in FX have managed to avoid showing a high sensitivity to tech/AI-led declines.
After a period of weakness in flows for high-yielding EM names and surprise rate cuts in APAC pressuring low-yielders, EM FX holdings remain near the highs of the year. There is even some improvement in profitability (Exhibit #1). We stress that in some cases, such as KRW, purchases may reflect unwinding of hedges rather than outright buying, so the asset allocation picture remains challenging. However, we don’t see any risk of a major round of disruptive liquidation that could trigger a broader rise in volatility.
Forward look
The outlook for high-yielding currencies remains favorable as long as domestic policy support through real yields is firm. For example, Central and Eastern European (CEE) central banks have now restarted easing cycles, but only in response to inflation falling to levels, which will continue to support real rates. There are idiosyncratic cases where higher fiscal outlays could challenge fixed income markets, but globally, these are isolated cases. If anything, we are more likely to hear EM finance ministers expressing concern over restrictively high nominal rates.
Meanwhile, savings-heavy low-yielders will face tightening financial conditions through the equity channel, but there is sufficient fiscal and liquidity-based policy space to limit the fallout. Additional fiscal support is expected in China and Japan. This fiscal support will likely limit growth weakness in the region and even strengthen the case for earnings-growth-based equity outperformance next year, supporting currency performance along the way.
EXHIBIT #2: POSITIONING OF EM EQUITIES IN GLOBAL PORTFOLIOS AND EM APAC SHARE OF EM POSITIONS
Source: BNY iFlow
Our take
As valuations peak in the U.S. or face a high bar for further gains, the prospect of further flows into emerging markets is coming to the fore. We established in iFlow this year that EM holdings have held their own, led by strong gains in EM APAC, where many corporates comprise a key part of the global AI capital expenditure ecosystem. China’s own ambitions for “high quality” growth have also driven re-rating in the local market. However, in absolute terms, ownership levels remain poor.
We recently introduced a new iFlow indicator called “positioning.” The figure tracks asset holdings, but the calculation for positioning represents the share of asset holdings in a submarket relative to the aggregate market. For example, for the purposes of this study, Exhibit #2 shows the EM equity asset holdings share of global equity holdings. Since “Liberation Day,” the share has been steadily rising and looks set to end the year close to 7%.
In relative terms, this increase represents a gain of around 13% from the immediate post-Liberation Day low. However, in aggregate terms, it underscores how under-positioned our custody clients are in EM equities. Comparatively, DM Americas alone represents nearly 72% of total holdings, more than ten times the level of all EM holdings. This is followed by DM EMEA at 16%, more than double the level of all EM holdings.
Forward look
Although the U.S. has reached trade agreements or accommodation with key EM partners, these economies have acknowledged the need to restructure their economies away from exports as traditional moves up the valuation chain through manufacturing may not be as clear-cut. Consequently, there is room for re-rating and for new sectors to emerge based on domestic demand.
EM economies are in a better position to achieve such gains as dependence on external capital – be it foreign direct investment or trade income – is not as pronounced as in previous cycles. However, there is still very high concentration risk in growth investment due to China’s dominance of various future growth sectors and the size of capital markets. Total EM allocations may have increased, but the share of APAC allocations within EM portfolios has also increased to close to 70%. The emerging market investment narrative remains strong, but asset allocators will need to decide carefully if broader diversification is desirable or if the result is risk heavy concentration in a few EM APAC sectors.
EXHIBIT #3: QUARTERLY FLOW AVERAGES, ACGBS, AUSTRALIAN CAST
Source: BNY iFlow
Our take
We see divergence within G10 currencies, although the general direction for EM continues to be easing in financial conditions through the rate channel for high- and low-yielders alike.
Japan is a unique case, but the most recent policy decisions and inflation data out of Norway, Canada and Australia suggest that commodity-linked currencies with very strong public finances are potentially done with easing. Further, a pivot towards tightening up ahead is possible to contain inflation expectations.
While we doubt any of these economies will tolerate significant divergence of financial conditions from the U.S. and Eurozone, adjustments in their bond and policy curves will likely affect currency markets, especially the most liquid names. Australia is at the forefront of such flows as the largest market, rated AAA and stable by all three major agencies in the APAC region. Flows into Australian Commonwealth Government Bonds (ACGBs) had already shifted in a positive direction in the second half of the year as easing by the Reserve Bank of Australia (RBA) slowed. More recently we have seen surge flow in related cash and short-term instruments (CAST). Currently, Australia is the best-performing CAST market globally, yet the flows we see across its fixed income curve are not being reflected in Australian dollar (AUD) performance.
Forward look
iFlow indicates that AUD holdings have been one of the most stable currencies measured by cross-border holdings, where international investors simply track their underlying asset exposures and choose not to engage in large marginal changes in their AUD exposures. Whether this matters over the longer term is another question. Although Australia is once again running current account deficits, the market has shifted toward the view that its currency behaves more like other EM and APAC funding currencies. In this view, the overseas flows and hedging behavior of domestic asset managers represents the marginal AUD buyer or seller. Should hedging activity pick up over time, as expected by the RBA, AUD re-rating could be significant, since these hedging flows complement the rise in international holdings of Australian assets, especially while valuations remain attractive.
