Since the beginning of this year, global funds have generally flowed out of U.S. dollar assets and returned to domestic markets, leading to a situation where non-U.S. markets have outperformed U.S. assets due to the spillover of U.S. dollar liquidity. According to the latest TIC data released by the U.S. Department of the Treasury, after valuation adjustments, in April, overseas investors reduced their holdings of long- and medium-term securities by $88.9 billion, including $59.2 billion in U.S. stocks and $46.0 billion in U.S. Treasury bonds. Regionally, Canada and Mainland China had the largest reduction in holdings.
For non-U.S. assets: Europe’s favorable policies, low-level economic recovery fundamentals, and frequent fund rotation between the U.S. and Europe have made European stocks the most benefited assets under the weak dollar. Europe is the largest overseas holder of U.S. stocks, with a total holding of approximately $8.5 trillion, accounting for nearly 50% of all country holdings. Since the beginning of this year, European investors have continuously reduced their holdings of U.S. stocks and repatriated funds to domestic markets. According to EPFR data, the net inflow of European stocks in the rolling 3-month period recently reached its highest level since 2010. If U.S. stocks weaken, there is still considerable potential for future fund repatriation.
Foreign capital inflows, southbound capital, and the Hong Kong Monetary Authority’s liquidity injections have supported liquidity in the Hong Kong stock market. While certain factors, such as DeepSeek, have changed the narrative logic for Hong Kong stocks, leading the market to reassess China and revalue Chinese assets, the improvement in profitability still needs to be verified. The current rally in Hong Kong stocks primarily reflects a valuation recovery under abundant liquidity: firstly, the weak dollar has driven foreign capital inflows; secondly, southbound capital has seen record net inflows; thirdly, after the Hong Kong dollar rose to the 7.75 strong side convertibility guarantee, the Hong Kong Monetary Authority released a large amount of Hong Kong dollar liquidity. The subsequent focus will be on the marginal changes in liquidity from these three channels.
The off-market liquidity in China A-shares is abundant and the opportunity cost is low, keeping on-market funds active. Since the tariff parity in April, the trading sentiment in China A-shares has weakened, with market turnover fluctuating between 1 trillion to 1.5 trillion yuan. The margin balance has not changed significantly, and ETF fund shares have steadily decreased. Foreign capital continues to flow out, and the market is largely focused on stockholdings, lacking incremental liquidity. Although the 10-year government bond yield has dropped to a low of 1.63%, reducing off-market funds’ opportunity cost, whether it will flow into the market still depends on new catalysts such as profit expectations and the profit-making effect.
In the medium-to-long-term trend, global liquidity has shown some new changes in the short term:
First, the easing of the Middle East situation has improved market risk appetite, temporarily driving funds back into risk assets. Meanwhile, the fundamental trend may influence medium-to-long-term capital flows. After the unexpected easing of the Israel-Palestine conflict, global equity assets generally rose, further confirming that risk-averse behaviors caused by local geopolitical conflicts will quickly repair in the short term. In contrast, safe-haven assets have generally come under pressure, with oil prices significantly retreating from highs, gradually returning to capital-driven pricing. Inflation concerns caused by high oil prices have alleviated, leading to a decline in U.S. Treasury bond yields. After the retreat of risk-averse demand, gold and the U.S. dollar have both weakened. The subsequent focus shifts to economic data and the Federal Reserve’s monetary policy stance.
Second, the “American exceptionalism” narrative has somewhat recovered. The outlook for a soft landing in the economy and the revival of the AI narrative may continue to support the performance of U.S. stocks. “De-dollarization” may be temporarily delayed, and U.S. Treasury bonds may trade weakly with expectations of rate cuts. In the short term, the net inflow of funds into U.S. stocks has stabilized and risen. According to EPFR data, as of June 18, the weekly net inflow of U.S. stocks reached its highest level since the beginning of the year, and U.S. Treasury bond fund inflows remained generally stable. In the medium-to-long term, the “twin deficit” pressure remains the crux of American exceptionalism, with the U.S. dollar and U.S. Treasury bonds being significantly impacted. However, the combination of a weak dollar and fiscal expansion may support U.S. corporate profits. Potential risks include a cooling U.S. economy and high interest rates suppressing valuations.
Third, the Hong Kong dollar quickly fell against the U.S. dollar, triggering carry trade expansion and expectations of liquidity tightening by the Hong Kong Monetary Authority. After the Hong Kong dollar touched the strong-side convertibility guarantee in early May, the Hong Kong Monetary Authority injected nearly HK$130 billion into liquidity, leading to “short Hong Kong dollar, long U.S. dollar” carry trades, and causing the Hong Kong dollar to quickly fall. At this point, although the HIBOR (3-month) and SOFR spread is nearly 2.75%, after the depreciation of the Hong Kong dollar, the 3-month forward exchange rate shows almost no arbitrage opportunities. Due to the short positions created by carry trades, there may be a reversal, and future depreciation pressure may stem more from U.S. dollar appreciation and capital outflows from the Hong Kong stock market.
If the Hong Kong Monetary Authority pulls back Hong Kong dollar liquidity, leading to a rise in HIBOR rates, there may be some short-term pressure on Hong Kong stocks, though long-term impacts are limited. As an offshore market, Hong Kong’s market participants are more diverse, including overseas investors, local Hong Kong investors, and Mainland Chinese investors. Changes in Hong Kong dollar liquidity may only be one channel affecting Hong Kong stock liquidity. Looking at actual data, the liquidity of the Hong Kong dollar measured by the HIBOR-EFFR spread is somewhat correlated with the performance of Hong Kong stocks, but the strength is notably weaker than the offshore U.S. dollar liquidity measured by the U.S. Dollar Index. With continuous inflows of southbound capital, Mainland Chinese investors’ pricing power in Hong Kong stocks has also been increasing.
Fourth, since May, China A-shares have generally maintained a fluctuating trend. The absence of profit-driven momentum, policy support, and abundant off-market liquidity have led to a rally in large financial (high dividend) stocks, small cap stocks, and active themes, with signs of spreading in recent days. Since April, banks have been the only sector with active net inflows of funds, mainly driven by retail investors, reflecting risk-averse demand. In the short term, banks still have support, but changes in risk appetite could increase volatility in the banking sector. Meanwhile, small-cap stocks have been mainly net bought by institutions, possibly driven by quantitative trading. Institutional funds are relatively more consistent, but if these funds retreat, small-cap stocks may face some adjustment pressure.