According to BAML’s currency strategists, a “rotation from bonds into equities seems inevitable to us, and it could be a great rotation taking into account the huge bond inflows since the global financial crisis.”
Clues about how currencies might react to a great rotation can be gathered from the price action that surrounded the mini-rotation from bonds into equities triggered in May by the debate over the Fed’s tapering its asset purchases.
According to BAML, currencies in countries that have experienced the largest equity inflows and the smallest bond outflows since the Fed tapering debate started should do well when the great rotation takes place.
Here are the bond and equity flows during Fed tapering debate (percentage of assets under management May 22 to August 7, 2013):
In other words, the US dollar is likely to be the best-performing currency. This also suggests substantial emerging market risks during the great rotation.
BAML’s analysis suggests that emerging market currencies that might be particularly vulnerable include the Brazilian real, renminbi, rouble, Turkish lira, Indonesian rupiah, Indian rupee and Thai baht.
From yesterday’s actions, even the Central Bank’s interventions are not helping the Real.
The uptrend in the dollar should remain even as the Brazilian CB intervenes, says Lopes Filho’s chief economist Julio Hegedus, who projects the dollar to be over R$2.50 by December.
For FIA professor Ricardo Rocha, the dollar may reach R$2.70 by the end of the year. The Fed’s policy in addition to the poor performance of Brazilian exports favors a higher exchange rate.
It’s going to be at least an interesting second half…