Remember the Great Rotation?
The concept picked up a lot of steam in January, when investors piled historic amounts of money into equity funds, prompting calls that bond funds would soon see a big exodus of money as investors "rotated" their funds into equities.
The outsized inflows witnessed in January moderated shortly thereafter. The whole time, though, money was still flowing into bond funds. So, not quite a Great Rotation.
BofA strategists have been some of the biggest proponents of such a shift. In January, they even suggested that perhaps it had already arrived.
Since then, it's been pretty quiet on the Great Rotation front.
This week, though, BofA credit strategist Hans Mikkelsen discusses what he calls a "Mini Rotation" underway in the market:
Mini rotation out of bond funds
The most recent accelerating daily outflows from high yield funds, and consecutive meaningful daily outflows from high grade funds, highlight the biggest risk this year – the rotation out of bond funds. Still, we doubt the increase in interest rates thus far is sufficient to sustain a more lasting rotation. However, should 10-year interest rates increase to 2.5% by 3Q or perhaps 4Q, we expect a meaningful rotation to take place out of high grade funds. Since Chairman Bernanke acknowledged almost two weeks ago that the Fed may start tapering sooner rather than later – depending on the data – we have seen continued outflows from long term high grade bond funds spreading to intermediate term funds as well.
With fairly consistent inflows to short term high grade funds, that shows some rotation out of duration within high grade funds, even if we have only seen two days of meaningful aggregate outflows. Should payrolls on Friday surprise significantly to the upside and 10-year Treasury yields increase toward 2.4%, we expect more outflows and widening pressure on credit spreads. However, a disappointing or in line number could halt total return losses and lead to a rebound in flows and spread tightening.
The chart below shows outflows from high grade and high yield corporate credit funds in recent days.
EPFR, BofA Merrill Lynch Global Research
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