Portfolio Risk Management — September 15, 2021

Inflation and Its Impact on the Stock-Bond Correlation: What history can teach us about their future relationship

For more than two decades, multi-asset class investors have relied on the inverse relationship between stock and bond prices for both portfolio diversification and downside protection in times of market turmoil. The recent surge in consumer prices, however, has triggered a temporary co-movement of stocks and bonds. So far, the Federal Reserve has managed to keep long-term inflation expectations anchored just under 2.5%. But a further rise, along with a surge in long Treasury yields, could lead to a more enduring shift in the relationship.

In this paper, we examine the historical interaction of equity and bond-market returns—both in the recent past and over the last 70 years—in an effort to identify the main triggers of shifts in their relative directions. We find that anticipated growth in consumer prices seems to be an important determinant, specifically when it deviates too far from the mandated (or even implicit) target of the respective central bank. Inflation expectations, in turn, are highly sensitive to monetary-policy decisions—predicted and actual—which also play a role. Finally, the levels of long-term sovereign rates and equity earnings yields appear to be significant, too. Empirical evidence from the 1970s and ‘80s indicates that stock and bond prices tend to move in unison when the corresponding yields are high, volatile, and of similar magnitude.


Christoph Schon, CFA, CIPM

Senior Principal, Applied Research