Bloomberg MacroScope 专栏：高通胀体制下股债相关性转正，60/40 组合的国债对冲价值结构性下降

Treasuries are set to keep falling out of favour as an equity hedge in 60/40 portfolios amid a return to a persistently elevated inflation regime.

A few weeks ago I showed that when 10-year yields remain above 5.25%-5.50%, the correlation between stocks and Treasuries has almost always been positive. That, however, raises more questions we should try to answer.

Specifically: why is there an inflection point in the stock-bond correlation, and why does this occur with yields around 5.25%? In trying to answer these I’ll show why 60/40 portfolios can no longer rely as much as they did on Treasuries as hedge for stocks.

Before tackling this, let’s start with the key investment implications. A positive stock-bond correlation means that stocks and bonds can fall together. For much of the time between 2000-2020, the correlation was negative. That made Treasuries an excellent hedge for stocks.

No longer. The foundation of 60/40 portfolios as well as risk-parity strategies, which are founded on the same principle – and which together hold in the region of $1 trillion-$1.5 trillion of Treasuries – is based on this premise, but if the correlation is persistently positive, hedging demand for USTs is likely to weaken.

This is just deduction, but we can try and show it empirically. The chart below illustrates that the stock-bond correlation, and the sensitivity of returns from risk-parity strategies (controlling for stocks), typically rose and fell together during the years when the correlation was negative.

The relationship persisted during the “transitory” rise in inflation in 2020/2021, with risk-parity funds perhaps reasoning this was not a fundamental shift. Yet over the last two years, risk-parity’s sensitivity to Treasuries has continued to drop to 15-year lows, even as the stock-bond correlation has most recently been rising again.

Once bitten, twice shy. This suggests that risk-parity funds have sensed a regime change where they can no longer rely on Treasuries as heavily as they used to.

It doesn’t end there though. Stocks and bonds moving together more becomes self-reinforcing. As demand for Treasuries drops, liquidity declines and term premium rises, structurally supporting yields and keeping stocks and bonds positively correlated.

So why is it that higher yields are associated with a positive stock-bond correlation? In fact, it’s not yields ultimately driving this relationship, it’s inflation. This observation gets us to the heart of the issue.

With inflation, as with yields, a bifurcated relationship in the stock-bond correlation can also be seen, with the stock-bond correlation having almost always been positive when core PCE is above 3%.

It turns out that 3% has historically been the level when non-linear shifts in inflation occur. A 2016 Fed paper notes that when unemployment falls sufficiently below its natural rate (ie the rate associated with full employment and steady price pressures), inflation responds disproportionately. The paper concludes: “Little in US history suggests a regime of stationary, stable inflation can be maintained for long at an average level of inflation much above 3 percent”.

Further, inflation shocks are more likely to be mean-reverting when it is low (core PCE less than 2%). When it is high, past inflation feeds into expectations and shocks become cumulative (from the pandemic to Ukraine and Iran, we have seen several such shocks in recent years). Price pressures become more persistent and more volatile in a high inflation regime.

What is the significance of 3% in core PCE? Below this level inflation seems to be seen more as background noise, but when it rises – and persists – above 3%, individuals and firms likely start paying more attention to it.

A GLO paper from 2022, Inflation and Attention Thresholds, shows that internet searches on inflation markedly pick-up above about 3.5% headline CPI (a level consistent with 3% core PCE based on the long-term average of the gap between the two series).

When inflation is higher overall, it’s more probable the prices of a greater number of goods and services individually are rising, and doing so more sequentially. And when inflation is elevated it becomes more relevant for wage bargaining and purchasing decisions.

All of this grabs people’s attention, and inflation expectations are more likely to become anchored to inflation itself, inducing a positive feedback loop.

This leads to persistently elevated inflation, leaving the Fed with less room to cut rates. Therefore in a slowdown, or when the risk of one increases, bonds move less inversely to stock prices, and the correlation between the two assets starts to rise to its more typical positive state (as it has been over the majority of the past 120 years).

Finally, 3% core PCE has historically occurred when the 10-year yield has been around 5.25%.

We have now established four key points:

The inflection in the stock-bond correlation at 5.25% in yields is due to the non-linear regime shift in inflation that has typically happened around 3% core PCE; Inflation above 3% is more likely to become entrenched because greater attention causes expectations to become unanchored; The stickiness in inflation biases the stock-bond correlation higher; and The resulting reduced demand for Treasuries supports the stock-bond correlation, repressing UST demand further.

With core PCE back above 3% and averaging just below that level over the last 12 months, the omens are not good for escaping the high inflation regime we have been trapped in for most of this decade. This is far from welcome news for the 60/40 portfolio.

Simon White is a macro strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice. The MacroScope column is a wide-angled take on the most important macro and market topics, rising above the short-term noise to get the big picture.

Story Link: The Treasury Market’s 3% Inflation Trap: MacroScope