If Stocks Wobble, Will Bonds Be There To Absorb the Blow?

Soggy stocks won’t necessarily mean surging bonds

By Richard Barley

Current market moves may reflect the passing of a surfeit of optimism on the part of U.S. equity investors about President Donald Trump’s administration. Photo: Evan Vucci/Associated Press

If stocks are hitting a sticky patch, are bonds bound to shine? That was certainly the case in the first half of last year, when sharp falls in equity markets helped push bond prices sky-high. But the backdrop is different this time around.

So far, March’s decline in stocks has been measured, with the S&P 500 only 2.3% off its peak, but persistent: the Dow Jones Industrial Average on Monday notched its longest losing streak in nearly six years. A correction in stocks, after a big run-up following the U.S. presidential election, would arguably be a healthy development.

The last sharp correction in the S&P 500 at the start of 2016 was certainly good for bonds.

Long-dated debt benefited in particular, with returns on Treasurys maturing in 15 years or more reaching 10% as stocks bottomed, according to Bank of America Merrill Lynch data.

The correlation between moves in stock prices and bond yields has been rising, suggesting the swing between risk appetite and risk aversion that has been a frequent feature of markets in recent years is back in play. And after the selloff in the wake of the U.S. presidential election, bonds have restored some of their ability to act as a shock-absorber when stocks get hit. But the bar for a big rally in bonds is higher than it has been.

Last year’s market moves were driven by several forces, including worries about China, falling oil prices and the threat of deflation. Central banks responded to that: the Federal Reserve paused its rate increases while the European Central Bank injected more stimulus. Inflation was well below target, and stuck at around zero in the eurozone. The stars were aligned for bond markets.

But since then inflation has picked up markedly and the global growth picture has improved too, particularly in Europe. The period of ultraloose monetary policy is coming to an end; the Fed appears more determined to raise interest rates. The current market moves may just reflect the passing of a surfeit of optimism on the part of U.S. equity investors about President Donald Trump’s administration. That is bad news for stocks but not necessarily a sustained reason for bond investors to party.

The real signal from bonds would come if short-dated yields started to decline too: that would show broader risk aversion and a reappraisal of the path of U.S. monetary policy. But it will take a bigger shock to investor confidence for that to occur. Unless that happens, soggy stocks won’t necessarily mean a sustained surge for bonds.

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