Key Highlights

• JPY attempts to reclaim safe-haven status
• Equity sentiment weaker in EM industrial
• Savings-heavy APAC economies face biggest steepening risk

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CHF and JPY flows nearly symmetrical until recently

EXHIBIT #1: MONTHLY SMOOTHED CHF AND JPY FX FLOWS

_{Source: BNY iFlow}

Our take

The franc (CHF) remains on the ascendancy in flow terms heading into tomorrow’s Swiss National Bank (SNB) decision, and we continue to see it as the top safe-haven currency. The contrast with the Japanese yen (JPY) is stark: Since the beginning of September flow, directions and magnitudes have been nearly symmetrical (monthly smoothed basis), whereas in the past we would have seen very close alignment if carry trades were taken off. The past few weeks, however, have seen a slight improvement in overall JPY flow and the monthly smoothed average has even reached positive at the end of November. Some rebalancing may have been in play, while Bank of Japan (BoJ) Governor Kazuo Ueda’s repeated interventions over the past week, affirming the need for a December hike, have also likely helped stabilize proceedings.

Forward look

Given that the holdings situation for CHF and JPY is also quite opposite (underheld for the former, overheld for the latter), the bar for concentrated franc inflows has always been low. The prospect of a lower cost of carry versus the USD has likely helped with further reduction in shorts, and the recent pullback in the franc has also made a more compelling valuations case. We continue to see the CHF performing well heading into next year, as the SNB remains confident in maintaining their current policy approach. Crucially, now that the EUR has pivoted, policy differentials have widened against Switzerland’s key trading partner, which will allow a stronger franc on other legs without severely impacting the real effective exchange rate.

Meanwhile, the JPY should also find sufficient support ahead of the upcoming BoJ decision, but its policy space will be shaped as much by domestic politics and fiscal aspects as by global differentials. Ueda’s commentary yesterday suggests a relatively benign view on inflation, but this will also be dependent on limited pass-through and tolerance for higher yields needed to anchor the JPY.

Our flows indicate tentative currency flow stabilization, but until markets gain confidence in Japan’s fiscal strategy, we doubt exposures will increase based on the JPY’s traditional safe-haven status. The CHF will likely continue to attract the lion’s share of risk-aversion-driven flows.

Equities: Industrial and tech sectors show biggest DM–EM divergence in short utilization

EXHIBIT #2: SHORT UTILIZATION, EM AND DM GICS LEVEL 1

_{Source: BNY iFlow}

Our take

Sentiment in developed market (DM) equities remains steady heading into the Fed and even on a relative basis, there is little evidence that markets are overly concerned about elevated valuations in certain sectors. The GICS level 1 sector with the highest level of short utilization (i.e., % of shares lent out that are being sold short in BNY’s lending program) is consumer discretionary, which underscores concerns over the labor market and real purchasing power.

Nonetheless, we believe that cleaner positioning after the recent sell-off and Fed easing has limited interest in adding to pricing for downside. In contrast, short utilization for GICS level 1 sectors in emerging markets (EM) is above their DM counterparts in eight out of the 11 we track. Furthermore, there are very wide divergences in four of them: utilities, IT, industrials and materials (Exhibit #4), which is a clear reflection of idiosyncratic risks across EM, especially in earnings.

Forward look

EM APAC companies dominate capitalization in EM equities, and short utilization will reflect concerns about performance in these markets. Although China’s push into industry, materials and IT is well-established, fears linger that growing market share will come at the expense of profitability. Beijing’s efforts to curb “involution” is one of the major asset allocation themes for this year and next, but so far there is very little sign of progress.

Furthermore, pricing for stimulus remains cautious (see below), but even if realized, any fiscal push in the region will focus on the consumer, where short utilization is relatively light and not divergent from DM peers. We continue to see a positive case for EM equities next year but recognize that current levels of sectoral utilization suggest leadership next year will shift from industrials to consumer sectors.

Fixed Income: DM steepening risk is about stimulus as much as inflation

EXHIBIT #3: CHANGE IN SOVEREIGN DEBT SHORT UTILIZATION, KEY GLOBAL ECONOMIES

_{Source: BNY iFlow}

Our take

From Canberra to Tokyo to Frankfurt, policy commentary this week has taken a distinctly hawkish turn, even though actual rate hikes are still quite far away. Nonetheless, bond markets are not taking any chances, given the sharp steepening moves seen across the sovereign space over the past cycle. Our short utilization data for fixed income highlight that Australia, Japan and Germany have seen the largest increases in the share of sovereign bonds that were lent out and sold short (Exhibit #3). Utilization was already rising for Australia and Japan, but the move in Germany is more recent.

Only Chinese government bonds have seen a substantial decline in short utilization, consistent with the prevailing inflation and policy narrative, where more stimulus is clearly necessary.

Forward look

Changes in short utilization across China, Japan and Germany reflect market expectations around the effects of fiscal stimulus.

The situation with Japanese bonds (JGBs) is well-documented. But this week’s moves in Bunds suggest public investment growth is back on track. Still, markets question the medium-term impact of fiscal stimulus, especially as hopes rise for a peace settlement in Ukraine and Germany’s government faces renewed scrutiny.

This week, for example, the German government is set to approve a record €52bn arms package, which is more in line with the investment narrative that has driven European equity and bond market price action this year.

In contrast, markets continue to await a consumer-focused stimulus package from Beijing. But the decline in short utilization suggests early expectations were muted for a strong signal from this month’s pivotal Central Economic Work Meeting.

As fiscal narratives converge across developed markets and savings-heavy APAC economies, we believe changes in short utilization of Australian government bonds (ACGBs), JGBs and Bunds will likely be repeated across core global bond markets.

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