The carry trade between USD and JPY has been a very popular trade over the past decade. As the interest rate differential between the currencies was significant, it enabled investors to lock about 5% of annual returns based on this interest arbitrage. The carry trade defines the process of borrowing funds from a low-yielding currency to invest in a higher-yielding currency. The position profitability depends on the interest rate differential but also on the predictability of the FX spot rate, as cost of hedging currency risk shrinks the profit. The Yen carry trade is now being undermined by several factors occurring:
• The interest rate differential has now shrunk at the 10-year level into 3% from the previous 5% where a Japanese investor could set and forget an investment in US bonds.
• USD volatility has increased sharply, and this is driving hedging costs up.
• The Trump trade policies are aimed at reducing the trade deficit with Japan and to the extent they are successful there will less reinvestment through the capital account from Japan.
Increasingly we believe that Japanese investors are looking to unwind or at least reduce their USD exposure, and that the Australian dollar offers an alternative source of yield.
US Economic Outlook
There is still a lot of water to flow under the bridge regarding the Trump Administrations approach to economic policy. Last week we were all affronted with the reality that under a strict interpretation of the US Constitution the US President cannot declare a general tariff at a country level under the ’emergency powers’. This is now a matter that will be debated in higher courts and at many levels. It is possible that the courts will not have made a final determination prior to the mid-term elections in late 2026.
A couple of observations:
- The definition of ’emergency powers’ may not be applicable to many countries, but much like the trade sanctions against Russia, we are confident that they will be judged applicable to China. Beyond the Chinese military aggression in the South China Sea there is the Chinese supply of fentanyl through the complicit Canada and Mexico, but it is the Chinese control of rare earth materials that is likely the real problem. Rare earths are now a pivotal part of the AI and in fact renewables battery production. This issue came to the fore at the end of the week when Trump accused China of breaking a key term of the agreement to pause tariffs when they did not lift the ban on selling rare earths externally. As far back as 2017 China communist politburo ordered the shifting of capital away from the construction industry (after a huge oversupply was generated by the centrally planned increase in construction activity in response to the GFC) and into the renewables industry. China realised that there was simply not known (or possible) sources of the necessary rare earth materials to produce the number of batteries required to achieve the Net Zero delusion. Their response was to go and buy all possible sources of rare materials globally. China now can control the cost of net zero unless the rest of the world relies only on pumped hydro to create batteries for renewables (it is an odd term given that the life of solar power is about 15 years and a wind turbine, made in China, only 10 years) .
Although one response from Trump has been to abandon net zero targets the problem is that rare earths are also a key input into the AI chip production and military production programs.
- The US Administration can keep altering the trade tariffs terms to prolong the legal actions or just begin with blocking imports on health and security grounds. This is something that China uses frequently.
- China agreed to the tariff pause only to waste time knowing that Trump will find it difficult to get Congressional tariff approval (if required) post the midterms.
- There is always the option of the President taking, the final negotiated tariff terms to Congress for approval.
- Much like the ‘pandemic lockdowns’ the damage will be done just by the disruption to global supply chains. Any business with production sourced from China, Vietnam and Malaysia is right now shifting contracts resources to US friendly countries like the Philippines. Goods and shipping from SE Asia and perhaps also the Euro Area are now being diverted away from the US (since April 9). This may mean that shipping and goods prices in the short term falls to some countries and rises only in the US.
Already in April US goods imports have shown a fall of 20%. This is the largest fall in over 30 years, but it needs to be noted that US imports have been distorted since the November US election by the threat, implementation and subsequent confusion connected with the Trump Administrations tariff policy. The following chart is instructive.
Up until the pandemic lockdowns in 2020 US Imports oscillated in a $220bn – $$265bn range for a long period. As soon as the global supply chains were restored from the pandemic US businesses dramatically increased their imports to $349bn. There were two main drivers of this increase in imports:
- Excess fiscal expenditure from the pandemic response and subsequent Biden policies kept Aggregate Demand very strong.
- Business inventories remained at and elevated level due to business stock piling ahead of another global supply chain disruption such as a pandemic or a war (the world has been dealing with a new level of aggression towards Ukraine, Israel and in the South China Sea where both Taiwan and the Philippines are threatened almost daily by China).
Then in anticipation of the Trump tariffs US business began to increase imports and stockpile from December 2024. Viewed in this context the fall in April that showed the steepest declines in Consumer goods (32.3%), industrial supplies (31.1%) and automotive vehicles (19.1%).
The 19.8% fall in imports in April to $276bn needs to be judged in the context of the extra imports in the months before. Imports have fallen back to where they were in November 2024. US businesses have stockpiled an extra $167bn of imports in anticipation of the tariffs that were effective from April 9.
Australian Private Capital Expenditure
A lot has been made by the media and biased major bank economists of the slightly weaker Private Capital Expenditure in the March quarter.
Total new capital expenditure in Australia unexpectedly contracted by 0.1% quarter-on-quarter in the first quarter of 2025, missing market expectations of a 0.5% expansion and following a revised 0.2% increase in the previous quarter. The decline was driven by a 1.3% drop in spending on equipment, plant, and machinery, partially offset by a 0.9% rise in investment in buildings and structures. Investment fell in non-mining industries (-0.9%) but rose in the mining sector (1.9%).
We would make the following points:
• Capital expenditure over the past 5 years has been disrupted by the pandemic.
• Over the year period capital expenditure has been quite strong in aggregate when compared to pre-pandemic levels.
• In an Australian context where there is a very narrow industrial base the data can be impacted to a great extent by specific company investment actions. Increasingly we expect that private investment will follow the large Federal Government investment foundations created by the ALP to pick winners.
Interest Rates
Bond yields declined last week as tariff-related tensions eased and fundamentals regained focus, with both inflation readings and economic data coming in on the soft side. Adding to the move was a late-week risk-off tone, as former President Trump escalated his rhetoric towards China. The U.S. 10-year Treasury yield fell eleven basis points to 4.397%, with the rest of the curve also declining by a similar margin. Notably, since mid-May, the long end of the curve has retraced more of its early May rise than the short end, reflecting a shift in rate expectations. Attention now turns to how Chairman Powell will respond to Trump’s renewed push for lower interest rates.
The fall in the past week of Australian rates has outpaced that in the US. This reflects increasing pessimism about the performance of the Australian economy and the large number of business leaders finally getting some spine and calling out the anti-business practices of government and industrial relations regulation. Australian GDP growth is anaemic whilst similar countries continue to grow – Canadas’ real GDP was just announced with an increase by 2.2% (ann.) to Q1 2025 end.
Major Credit Markets
Credit markets have held their recovery since the April tariff rout; however, the average investment grade (IG) margins are still 8 bps wider than YTD lows in February. IG funds continue to attract inflows as an attractive asset class compared to the recently volatile equities, especially IG credit funds with low duration, that is, funds that isolate the credit spread.
May ended on a strong note, with a notable rally in both senior and subordinated note spreads, reversing the volatility experienced at the end of April—much of which was driven by tariff-related headlines. Primary markets remained firm, with new issues in May readily absorbed, supported by strong demand from Asian investors. Non-bank issuance also saw solid performance, and in general, corporate bond spreads tightened by 7–12 basis points. That said, it is important to view the tightening in context, as it followed a soft April, during which spreads had moved wider.
High Yield Markets
Global High Yield (HY) markets remained stable last week following the April spike in spreads and a partial recovery through May. Despite the steadiness, HY issuance remained subdued, as ongoing tariff-related uncertainty dampened activity. The anticipated surge in M&A-driven supply also failed to materialise, leaving only better-rated BB issuers able to successfully bring deals to market. In contrast, the lower-rated CCC segment continues to show signs of strain, with a growing number of distressed names deterring institutional investors from engaging. Encouragingly, however, the latest rating data from the U.S. HY sector shows a net positive trend, with earnings-related upgrades outpacing downgrades so far this year.
The hybrid market weakened again last week, with the average major bank hybrid margin widening by 12 basis points to 2.26%. Trading volumes were elevated, reaching 130% of typical daily levels, with selling activity heavily concentrated at the short end of the curve. Notably, NABPF, CBAPJ, and NABPH—all maturing in 2027 or earlier—led the volume.
Listed Hybrid Market
Hybrid Margin curve flat as a Brick-carters hat.
As noted, increased volumes at the short end of the hybrid curve have led to a flattening of the curve. In the chart below, the blue dots represent the most recent margins, illustrating the current flatness of the curve. In contrast, the red dots—positioned just below—show margins from the previous week, when the curve exhibited a more typical upward slope. (Each red dot corresponds to the label of the blue dot directly above.)
Overall, margins across the curve have widened, particularly in shorter-dated hybrids such as NABPG, CBAPJ, WBCPJ, CBAPI, and AN3PI. This shift may have been driven by a large private credit issuance during the week, which prompted selling to fund allocations. However, swapping hybrids for private credit is not a like-for-like exchange—especially from a liquidity standpoint, where selling a diversified basket of hybrids to purchase a single private credit security introduces greater risk. It also marks a shift from fixed redemption dates to a rolling, perpetual structure.
For buyers, this wave of selling has created an opportunity to acquire 1- to 3-year hybrid maturities at significantly wider margins compared to the previous week.
Forward Interest Indicators
Australian rates
Swap-rates are volatile with bond rate moves.
Swap rates:
- 10-year swap 4.13%
- 7-year swap 3.87%
- 5-year swap 3.65%
- 1-month BBSW 3.75%
