Key Highlights

• Term-of-trade improvements are real, but positioning caution is necessary.
• Bonds continue to struggle but peak hawkishness may be approaching.
• Dollar revisits exceptionalism as trade-weighted holdings remain near the highs.

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Broad recovery, but commodity names face headwinds

EXHIBIT #1: EXPECTED EQUITY REBALANCING FLOWS, END-APRIL

_Source: BNY

Our take

Asset allocators are likely to enter month-end rebalancing without a clear overarching theme, as ceasefire talks remain mired in uncertainty. On balance, the month has not exhibited a uniform risk-off profile, and there are tentative signs that risk appetite has recovered, in some cases independently of conflict developments in the conflict. Whatever the underlying drivers of these flows, the broader thematic imperative to add risk will likely outweigh any mechanical rebalancing need – particularly in U.S. assets and the pre-conflict AI segment. Most equity markets remain well below their pre-conflict levels in holdings terms, reflecting persistent disengagement from institutional investors – a pattern we have flagged before. Consequently, April month-end flows could provide an early indication of renewed demand for these assets, particularly where valuations across FX and equities are aligned favorably.

Across individual asset classes, the recovery in sentiment has not translated into particularly strong rebound flows in equities. Based on standardized returns, commodity-linked markets continue to outperform, most notably Norway, Brazil, and Canada, all of which are benefiting from petroleum-driven, positive terms-of-trade shocks. In contrast, China and India have led underperformance within EM, while New Zealand has marginally ranked as the weakest-performing equity market in the G10. Importantly, there have been no extreme score readings that would typically drive FX rebalancing purely via asset flow channels. For now, equity recovery appears to be a largely self-contained story, driven by positioning and valuation dynamics, and remains contingent on further conflict developments.

Forward look

When netting asset performance against FX moves, the comparison with March suggests only very limited scope for rebalancing flows. CAD and NOK stand out as the only currencies with meaningful exposure to such dynamics, though markets have already ended the month significantly overweight commodity-linked assets, implying some degree of adjustment may be necessary. Oil prices are expected to remain a structural support for these economies through year end, making equity exposure reductions challenging; any offset is more likely to come through hedging flows. This is particularly relevant given that central banks are unlikely to respond aggressively with rate hikes despite stronger demand stemming from favorable terms-of-trade shifts. If anything, there are clearer catalysts for a reversal, including Canada’s trade exposure to the U.S. and a potential reversion to net NOK selling by Norway’s central bank.

Fixed Income: The Americas stand out for sovereign bond resilience

EXHIBIT #2: EXPECTED BOND REBALANCING FLOWS, END-APRIL

_{Source: BNY}

Our take

Fixed income came under significant pressure in March as the energy supply shock drove a broad-based rise in inflation expectations. This theme persisted into April, although markets have started to differentiate more clearly across regions. Japan emerged as the worst performer, which is unsurprising given the starting point of already low nominal yields and the failure of repeated efforts to rebalance in JPY’s favor. With the country’s heavy reliance on energy imports, inflation expectations are likely to continue rising without a more forceful policy response from the Bank of Japan (BOJ). Meanwhile, both the U.K. and the Eurozone experienced further curve steepening amid stagflation concerns, though we don’t view conditions as supportive of rate hikes from the ECB or Bank of England, which could in turn allow for improved performance in May. In contrast, Brazil, China, and Mexico were the only markets to deliver positive returns, with Latin American economies supported by relatively high nominal and real rate anchors, while China appears to benefit from a lower starting point for price levels and underlying disinflationary pressures.

Forward look

Within fixed income, rebalancing risk remains relatively contained, with only modest potential inflows into EUR and JPY. The recent BOJ decision may not have materially shifted market perceptions around JPY performance, but the shift toward net selling in recent weeks, combined with persistent JGB curve steepening, has left global fixed income portfolios meaningfully underweight and in need of some offset. At this stage, it matters less whether the adjustment comes via the JGB market or the currency channel – both ultimately serve the same purpose of containing Japan’s inflation expectations. For the EUR, fixed income flows have been primarily domestically driven, while cross-border demand remains subdued. Given that EUR valuations have already advanced, incremental demand is more likely to be expressed through increased bond allocations rather than currency exposure.

FX: Mixed flows ahead of Fed; TWI-based holdings near YTD highs

EXHIBIT #3: MONTHLY SCORED FLOWS, CORE USD PAIRS

_Source: BNY 

Our take

The dollar won’t feature heavily in the FOMC decision today (or in general) but on the margins, the past two months may yet be seen as a net loosening in financial conditions because the conflict has generated excess demand for dollar liquidity. Previously, there were concerns about competitiveness erosion, but in the near term the U.S. is benefiting from a positive terms-of-trade shock, so there’s no need to lean against it. Dollars will be recycled into the U.S. economy for practical purposes, and if some disinflationary pass-through can be generated in the meantime, then the Fed need not deviate much from prior scenarios.

Our flows indicate that the dollar may have suffered some flow losses against the likes of CAD and CNY. Good performance against EUR, JPY and MXN means dollar holdings remain elevated on a trade-weighted basis, but not to a degree that would generate significant rebalancing flow to the downside. In the current environment, we expect the bar for technical USD selling to remain high.

Forward look

As U.S. equities have recovered well but not to the dollar’s material detriment, then it is worth revisiting the U.S. exceptionalism story where all U.S. assets can gain ground at the same time. This would mark a departure from pre-conflict flows, where interest in U.S. assets held well, but we witnessed greater hedging interest. In EURUSD at least, the unwinding of those hedges has continued over the last two months, and a hawkish ECB does not appear to be changing the picture due to strong stagflation risk in the Eurozone. There might be some minor alternatives such as CNY, JPY and even CAD, but a yield drag will remain in place for all. If the conflict does move gradually toward resolution, trade surpluses will start flowing again and most of the dollars generated will continue to find their way into the U.S. asset market. Hedging flows thereafter, especially with an anticipated dovish Fed, will determine the markets’ tolerance for higher dollar weightings.

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