Goldman: Sharp Contraction In Cross-Border Flows Likely Supporting USD

Goldman Sachs think “volatility in global mutual fund and ETF flows best explains the recent fact pattern across macro markets, including strength in the USD. Over the last four weeks, investors have net sold/redeemed $39bn of equity fund products and $26bn of bond fund products - the first substantial outflows since March/April 2020. Cross-border fund flows also typically contract in periods of heightened risk aversion, supporting the “safe haven” USD. Our measure of FX flows - net purchases by non-resident funds, excluding FX-hedged products and hard currency EM funds - shows a contraction in demand for all major currencies, with especially large outflows from CNY (note that this measure also includes inflows to/outflows from the HKD-denominated H-Share market). This dynamic has likely supported USD, in our view, as it did in the early stages of the COVID pandemic.”

• “We are not convinced that the heavy fund outflows are entirely behind us, but they may mean that some assets, including USD, could be overshooting “fair value”. In terms of fundamental news, Wednesday’s FOMC meeting and Friday’s U.S. employment report were arguably net negative for the greenback, as they reduced hawkish tail risks around mid-year funds rate pricing. But even if Fed-related fears have eased on the margin, investors are still faced with downside risks to European economies from the war in Ukraine, and to the Chinese economy from weaker-than-expected policy support. This combination of adverse fund flow technicals and tail risks to global growth should remain positive for the U.S. Dollar.”
• “We therefore stick with moderately defensive trades for now, including our recommendation to go long EUR/GBP. We close our short AUD/CAD recommendation, at a small loss: if Fed pricing has topped, this may no longer be an appropriate “risk off” trade. Instead, the Yen arguably offers the most convexity in the event of further equity drawdowns and rising global recession risk. Investors should consider Yen calls (USD/JPY or AUD/JPY puts) to protect portfolios for this scenario.”