Bonds Useless as Hedge to Stocks

Bonds Useless as Hedge to Stocks

The role of bonds as a “shock-absorber” and safe haven has “eroded as the fear of inflation becomes a common denominator for both stock and bond investors.” This according to a recent Bloomberg article.

Since 2000, the article notes, investors have grown accustomed to what the article describes as a “stock-down-bond-up” scenario. Before 2000, a positive correlation between the two asset classes was more common because inflation was more volatile. The article argues that if the current trend continues, “it would mark a sea change as strategies such as risk-parity and 60/40 are likely to become more volatile.”

The article quotes Nomura Securities strategist Charlie McElligott, who contends, “Long bonds as your hedge worked in a Goldilocks era” of stable growth and inflation, adding, “But now, due to the pandemic response, that old dynamic simply no longer applies. Inflation is a volatility catalyst.”

Even though the U.S. consumer price index has risen significantly, the article reports that the Fed has insisted the surge is “transitory” and therefore will be measured in its approach. According to McElligott, if the Fed is correct, the bond-stock correlation could normalize. “Only in the case of an extreme inflation overshoot would the Fed’s hands be tied,” he said, a situation that would force a rate increase.