Key Highlights

• Brazilian assets face comprehensive rebalancing pressure
• Strong month for European equities requires adjustments
• Defensive rotation continues amid tech struggles

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Equity rebalancing: Carry unwind led by BRL, ZAR and MXN

EXHIBIT #1: CURRENCY FLOW ESTIMATE – EQUITY REBALANCING

_{Source: BNY, Bloomberg}

Our take

February 2026 is likely to see significant equity-based rebalancing, reflecting a combination of strong currency flows and resilient equity performance in select markets.

The bottom line: It was not the best month for U.S. equity exposures. A tech-led selloff, alongside renewed demand to add to USD hedges – irrespective of underlying NAV performance – drove strong rotational flows into emerging markets. These markets are seen as having defensive exposures against both factors.

After a poor start to the year, the BRL was the best-bought EM currency in iFlow this month. Meanwhile, IBOVESPA enjoyed another solid month of inflows and looks set to end February up more than 25% year to date. Meanwhile, its fixed income market also performed very strongly (see below). Consequently, a strong rebalancing signal is in place. This is no surprise, with USDBRL at its lowest level since Q2 2024. ZAR and MXN currency flows were largely flat, but their equity markets escaped much of the U.S. gyration. This is also driving rebalancing interest.

We would also associate NOK rebalancing needs with carry names. The OBX looks set for one of its strongest months on record as oil prices recover. That performance requires additional NOK sales to rebalance, even though iFlow indicates some selling has already come through. EUR and GBP were supported by good equity interest and also performed well in iFlow in February. European asset managers likely added to dollar hedges.

The JPY also had a strong month of purchases. Markets hope authorities will tolerate further JPY strength. The Nikkei is also strongly outperforming regional peers. However, we suspect some fault lines are emerging as the new government takes shape.

Forward look

A carry unwind and reversal of excessive U.S. diversification or rotation are the main themes in major FX rebalancing.

The market seems spoiled for choice in rebalancing candidates, but adding to U.S. exposure offers the best risk-reward. On balance, adding to LatAm and EMEA FX hedges remains relatively expensive. A reversal in EUR, GBP and JPY offers better risk-reward, suggesting a trade-weighted dollar rally is due.

Fixed income rebalancing: BRL and EUR lead

EXHIBIT #2: CURRENCY FLOW ESTIMATE – FIXED INCOME REBALANCING

_{Source: BNY, Bloomberg}

Our take

In fixed income, BRL rebalancing pressure is even stronger. That is no surprise given elevated real rates, which continue to attract inflows into Brazil and broader LatAm. Indirectly, Colombia’s rate hike may also have revived expectations of renewed tightening across LatAm. However, with the Selic already highly restrictive in nominal terms, there is limited scope for acceleration without risking a serious political backlash.

As indicated in the equity section, total asset exposure in Brazil is now excessive, and asset reduction may have to be part of the story for rebalancing. This may be less costly than significantly increasing currency hedges. Otherwise, the only carry currency at risk is ZAR, and the relevant drivers are well-established. Unlike the case in equities, MXN does not face strong rebalancing risk due to softer fixed income positioning, though we suspect recent events could drive incremental hedging.

The EUR faces outflows due to currency performance. CNY is also included, as its bond market continues to perform strongly. Market expectations for additional stimulus increase ahead of the National People’s Congress, which opens in early March.

Forward look

Combined with equity rebalancing, BRL, ZAR and MXN are clearly at risk of hedging flows, or in the case of Brazil, complementing some asset reduction.

We fully acknowledge that real rates in LatAm and much of EMEA remain attractive, but it is very difficult to suddenly attach haven status to these currencies. At best, a monetary response to near-term supply shocks could help. If global equity markets deteriorate further and fears of AI-led economic contraction materialize, a quantitative-driven response would likely support economies with high real rates and commodity backing.

On the other hand, it is difficult to make a strong asset allocation for EM FX while risk aversion sweeps developed markets, so the balance of risks continues to skew against carry performance for the rest of the quarter.

Asset allocation: Defensive rotation clearer at industry group level

EXHIBIT #3: SMOOTHED WEEKLY FLOWS – GCIS® LEVEL 2 INDUSTRY GROUPS

_Source: BNY 

Our take

Global rotation away from the U.S. will drive month-end FX rebalancing, but similar sectoral shifts may emerge within the U.S. as well.

After consecutive sessions of AI-related selling in the tech segment, there are initial signs of relief toward month end. However, the market is still very sensitive to new releases by AI firms, which threaten to disrupt existing platforms. A defensive posture has come through in the U.S., pushing equity flows into associated sectors.

On a GICS® Level 2 (industry group) basis, we note the strongest flow divergence is away from Software and Services and into Household and Personal Products, which is within the Consumer Staples sector. On a smoothed weekly basis, selling in Software and Services matches buying in Household and Personal Products. However, flow magnitudes have not accelerated into month end, suggesting allocators are not yet rushing to increase rotation.

Forward look

Valuations will start to weigh on these flows in both directions toward quarter end, so sectoral rebalancing may prove more pronounced in due course, especially if tech-related earnings continue to deliver.

Nonetheless, Fed officials are fully cognizant of the uncertainty surrounding labor market disruptions from AI. Further financial conditions relief may follow if the broader market continues to correct. If so, further slowing in rotation flows is likely, but it would fall short of a full reversal.

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