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One of the major themes for this decade is the possibility of money being taken out of bonds and put into equities. This is the so called Great Rotation. No one knows when this will be exactly but the narrative is that the fundamentals for bonds are poor, and have been for years, while the fundamentals for equities (stocks/ shares) are good and improving. Before that happens, or perhaps concurrently, I'm looking at the causal relation between bonds and currencies.

My thoughts go like this: if the fundamentals of bonds are poor then eventually we will see them sold off. When bonds are sold off they are exchanged for the currency in which the bonds are denominated. A US government bond (say) is obviously exchanged for US dollars. This means that if there is a sustained sell off in US bonds then there will be a sustained demand for US dollars. Said another way: a decline in the price of US bonds and a strengthening of the US dollar. This is probably true of all bonds and currencies; as bonds positions unwind then I think currencies will strengthen. That will be the first stage of the so-called Great Rotation.

The key assets to watch will be the bonds and currencies of greatest size: eg. USD, EUR. An important consequence of the dollar strengthening is the decrease in commodity prices. Let me re-state that as commodity prices having a headwind due to a strengthening dollar. It could also be possible for commodity prices to increase if demand outstrips supply even after accounting for dollar strengthening. This is last point is one which I am the most unsure of. At the time of writing the commodity prices are weakening while the dollar is strengthening, bonds are also selling off too. So all of what I've said would seem to be coherent. The catch is that I don't think this is the bottom of the bond market just yet. I might be, but I'm not confident enough to call it that. The trend doesn't quite look right for a market bottom (in yield terms). I think there will be another test of the low price and we will possibly see a double bottom (or a double top in price terms), from there I'd be looking for yields to rise (prices to drop).

I feel less confident about the causal relation to commodities here as commodity fundamentals aren't terribly weak. I think there is greater fundamental reasons to hold commodities over bonds, but that's not to say that the market agrees. If capital moves from bonds into cash then it could "deflate" commodity prices (despite fundamental strength). It is also possible that money which flows out of bonds could eventually find itself in commodity funds (demand increase).

The next step in the Great Rotation is when cash is spent on equities. The flow of capital into equities will push stock markets higher. It is worth noting that the global bond market is nearly $100 Trillion (see wiki), while the size of the global stock market is around $30 Trillion. It is easy to see that outflows from bonds can easily be put to work in equities. This rotation obviously won't happen overnight and has most likely already started. Prices don't move in straight lines and the prices of bonds may not have quite started their reversal just yet.

My logic here would be to look at currencies and equities. Ignore or sell out of bond positions (not necessarily short). Commodities I am less sure about and need to put more thought into them. A driver for commodity price increases would be if China's demand for commodities increases as the standard of living improves on the back of their currency appreciating. If the demand (chiefly in China, although really I mean globally) for commodities outstrips the supply then we are looking at bullish fundamentals for commodity prices. As always the market will confirm or deny such thinking. Positioning yourself to go against the market will lead to guaranteed pain.