MARKET INSIGHTS

Positively Negative:
Stock-Bond Correlation and Its Implications
for Investors
February 2019

Introduction
One of the most important shifts in the investment
landscape over the past two decades has been the emergenceof a negative correlation between stock and bond returns.
This shift has transformed the basic hedging properties ofbonds, giving them a more substantial role in the constructionof efficient, diversified portfolios for investors.
This change contributed to a sizable repricing of fixedincome instruments over this period. As investors increasingly
recognized that government bonds had become aneffective hedge for the equity assets held in their portfolios,
the term premium on bonds gradually declined, evenreaching negative levels in recent years. This decline in theterm premium created trillions of dollars of wealth for theholders of fixed income assets.
Yet, despite the fundamental importance of the stock-bondcorrelation for bond pricing and for investors’ portfolios
generally, its underlying drivers are not well understood,
leaving considerable uncertainty about what to expect going
forward. Many observers simply assume that the dynamics
observed over the past two decades will persist. Others havesuggested that the correlation is on the cusp of shifting backto a positive regime—a development that would havesubstantial consequences for financial markets. 1 In either
case, it is hard to have confidence in the view without first
determining what developments have pushed thecorrelation to its current levels.

Under this explanation, the path forward would hingeon how well central banks manage to achieve ongoing
success on that front. If they can continue to control
inflation and inflation expectations to the same extent
that they have in recent years, government bonds should
continue to offer attractive hedging properties, and the
downward adjustment of the term premium observed todate could persist or even run further at longer maturities.
If, instead, central banks falter and inflation again becomesunmoored, markets could snap back to a regime of
positive correlations, potentially pushing the term premium
much higher.
In our view, the former outcome is much more likely.
The fundamental driver of the negative correlation—
central banks’ success in managing inflation—will likely
remain in place, with the consequence that the term
premium will likely remain low relative to its historical
average. Nevertheless, given the significant portfolio
implications of those different outcomes, it is importantto understand the range of potential future scenarios andthe factors that might tip the scale between them.

In this paper, we argue that the negative correlation regime
observed in recent decades has been driven to a large
extent by the success of the U.S. Federal Reserve andother developed-economy central banks in reducing
inflation and keeping inflation expectations relatively
anchored. This success, in turn, has resulted in asset pricefluctuations generally being driven by perceived changes inthe strength of economic activity or shifts in risk
sentiment—developments that generally induce a negative
correlation.

1

See, e.g., “Two-Decade Rupture in Stock-Bond Link Flashes Global Market Pain,” Bloomberg, October 10, 2018.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors

1

Stock-Bond Correlation
and Its Drivers
The meaningful shift in the relationship between government
bonds and stocks is readily observable in a time series plotof the correlation between their daily returns. As shownin Figure 1, a negative correlation regime in U.S. markets
began at some point around the late 1990s, following theperiod of positive correlation that had prevailed over theprevious three decades.
We believe a major ingredient in this shift was the successof the Federal Reserve in bringing realized inflation rates tolow levels and stabilizing inflation expectations at thoselevels, as well as the greater clarity the Fed offeredconcerning the policy framework for maintaining thatoutcome. 2
To understand this argument, it is important to recognizethat the connection between equity and bond prices
depends on the factors that drive their respective
fluctuations. For both bonds and stocks, the values of
future cash flows are determined using discount rates thatreflect the time value of money, making both assets
sensitive to that variable. However, the relative responsesof these assets to a shift in discount rates are not uniform,
but rather depend on what factors are driving that shift.
The following four scenarios offer a simple framework forunderstanding the factors that drive changes in stock andbond prices:
1) Suppose yields rise because the central bank is expected

to tighten policy in response to an unexpected rise ininflation or inflation expectations. In that case, one might
expect stock prices to fall along with bond prices. The
negative response of stock prices reflects the belief that
nominal interest rates will typically move by more thaninflation, that economic activity will decline in response,
and that the equity risk premium might rise in a morevolatile inflation environment. 32) A similar dynamic arises if investors revise their view ofthe policy inclinations of the relevant central bank for agiven set of economic conditions (that is, there is a shift
in what is often called the central bank’s “policy rule”).
If yields rise because the central bank is suddenly seen as
taking a more hawkish approach, equity prices would
likely fall due to higher discount rates, as in the previous
scenario. In fact, the situation for equities is somewhat
worse, in that there is no positive effect on nominal
dividends from higher inflation.

Figure 1: Correlation Between S&P 500 and 10-year U.S. Treasury Returns
0.8
0.6

Correlation

0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006

2010

2014

2018

Axis
Title
Correlations based on daily returns using exponential weighting
witha 2-year half-life. Source: Bloomberg.
2

The role of central banks and economic factors in influencing the correlation and associated risk premia are explored through use of a formal
asset-pricing model in a National Bureau of Economic Research working paper by John Campbell, Carolin Pflueger, and Luis Viceira,“Macroeconomic Drivers of Bond and Equity Risks,” © April 2014, revised August 2018.

3

Because equities are a real asset, it is tempting to assume that shifts in inflation prospects would have no effect on their value. However, that is
not the case if the central bank is adjusting the real interest rate and affecting real activity in response to an inflation shock. It is also not the case if
perceived risk, and hence the equity premium, is responsive to a change in the inflation environment.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors23) The situation is very different, though, if an increase in

Table 1: Four Scenarios for Equity and Bond Returns

yields comes in response to improving prospects for
economic growth, perhaps as the economy emerges
from a recession and investors gain confidence in therecovery. While this increase in yields again reflects ahigher expected interest rate policy path by the central
bank, investors also would expect higher earnings
growth in this case, potentially outweighing the dragof higher interest rates and boosting equity prices.
4) Lastly, it is worth considering the scenario in which asset

price movements are driven by a shift in the risk appetiteof investors. If investors become more willing to holdrisky assets, whether because they perceive less overallrisk or simply become more tolerant of risk, they willtend to push equity prices higher and bond prices lower.
As summarized in Table 1, the first two scenarios tend tocreate a positive correlation, while the last two create anegative correlation. (Table 1 is expressed in terms ofdevelopments pushing bond prices down, but therelationships hold if the factors move in the other direction.)

Asset Price
Response(1)
HigherInflation
Expectations(2)
HawkishPolicySurprise(3)
Stronger
Expected
Growth(4)Higher Risk
Appetite

Equities

Neg

Neg

Pos

Pos

Bonds

Neg

Neg

Neg

Neg

This simple framework can go a long way towards
explaining the shift in correlation in U.S. markets
described earlier. As shown in Figure 2, longer-term
inflation expectations were high and variable over asizable portion of the past 50 years, reflecting the poor
credibility of the Fed in delivering low inflation andconsiderable market uncertainty regarding the Fed’s
policy approach. Under those circumstances, the factors
reflected in the first two columns of Table 1 were criticaldrivers of market fluctuations, inducing a positive
correlation between stocks and bonds.
However, the situation appears quite different since
the late 1990s, as the Fed has managed to stabilize
inflation expectations at around two percent. Over thisperiod, the Fed has also become clearer about its policy
framework for maintaining that outcome, boosting its

Figure 2: Long-Term Inflation Expectations and 10-year U.S. Treasury Yield
8%

18.00%

7%

15.75%Inflation Expectations (LHS)
13.50%

Yield (RHS)

5%

11.25%

4%

9.00%

3%

6.75%

2%

4.50%

1%

2.25%

0%
1968

Yield

Inflation Expectations

6%

0.00%
1973

1978

1983

1988

1993

1998

2003

2008

2013

2018

Long-term inflation expectations refer to the 10-year expected PCE (personal consumption expenditure) inflation measurefrom the Federal Reserve Board's FRB/US model, which we splice (beginning in 2014) to 5- to 10-year inflation
expectations from the Consensus Economics survey. Source: Bloomberg; Consensus Economics.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors3

credibility among investors and making its policy
decisions more predictable. This policy success has
diminished the importance of the factors in the first two
scenarios of Table 1, leaving the market to be driven
more substantially by shifts in growth prospects and risk
preferences, inducing a negative correlation. 4

The relationship also appears strong when measured
against the 10-year Treasury yield, as that yield
incorporates the broad patterns in inflation expectations(see Figure 3b).
Because we know that the correlation shifted downward
so strongly in the 1990s, it would be easy to find an
apparent relationship with any variable that was also
trending over this period. So why do we believe that the

The relationship of the realized stock-bond correlation to
inflation expectations is notable, as shown in Figure 3a.

Figure 3a: Stock-Bond Correlation Versus Inflation Expectations
1.0
0.8

Pre-1997

0.6

Post-1997

Correlation

0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

Inflation Expectations
Quarterly correlations based on daily returns of the S&P 500® and 10-year U.S. Treasury note. Inflation expectations refer to the
10-year expected PCE inflation measure from the Federal Reserve Board’s FRB/US model, which we splice (beginning in 2014) to
5- to 10-year inflation expectations from the Consensus Economics survey. Source: Bloomberg; Consensus Economics.

Figure 3b: Stock-Bond Correlation Versus 10-year U.S. Treasury Yield
1.0
0.8
Pre-1997
Post-1997

0.6

Correlation

0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
0%

2%

4%

6%

8%

10%

12%

14%

16%

Yield
Quarterly correlations based on daily returns of the S&P 500® and 10-year U.S. Treasury note. Treasury yield computed as quarterly
average. Source: Bloomberg.

4

In addition to the empirical results reflected in Figure 2, this shift can also be seen in simple macroeconomic models that describe the economy
with a few simple equations (see, for example, the structure of the model used in the Federal Reserve Board working paper “Short Takes on
Monetary Policy Strategy: An Introduction to Some Basic Concepts” by James A. Clouse, FEDS#2018-089). According to those models, it appears
that shocks related to inflation (as determined by a “Phillips curve”) and short-term interest rates (as determined by the Fed’s policy rule) havediminished significantly over the past two decades.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors4

shift has to do with inflation? One reason is that theeconomic developments underlying this explanation were
notable and also generated meaningful shifts in the
behavior of other key variables. For example, researchers
have found that the stability of inflation expectations since
the late 1990s in the United States significantly reduced
the persistence of inflation itself. 5
There is also support for our hypothesis from patterns
observed across other countries. The shift in the stockbond correlation has occurred in almost all advanced
economies, and it generally lines up with inflation
expectations reaching low levels in those cases. A
particularly informative example is Japan, where thecorrelation turned negative earlier than observed in othercountries, coinciding with an earlier decline in inflation
expectations in that country. (Please see the Appendix forfurther discussion of this international evidence.)

Zooming In on the Correlation
Our hypothesis relies on the changing importance thatmarket participants assign to different types of information.
Under this explanation, the move to a regime of greater
inflation stability and more predictable monetary policy has

been the primary driver of the broad shift to a negative
stock-bond correlation shown in Figure 1. However, even
within this recent regime, one might still expect to findpredictable variation in this correlation when measured
over periods in which market participants perceive thearrival of different types of information.
To investigate that possibility, we find it useful first tozoom in the lens and examine the stock-bond correlationin the United States using the same methodology as in
Figure 1 above, but with a shorter half-life (40 days
instead of two years). As shown in Figure 4, the negative
correlation that appeared relatively steady when measured
over a longer half-life now appears to be more variable.
Moreover, there have been five periods since 2011 when
the correlation has become markedly positive. Each ofthese spikes corresponds, in our view, to periods ofdisproportionate concern over the Fed’s policy approach(scenario 2 from Table 1).
That narrative is useful, but it is somewhat ambiguous
to claim that these episodes were driven by changing
perceptions of the policy approach. To be more careful
about the categorization, we can zoom the lens in one
step further and investigate whether the correlation looks
different on days when market participants receive more

Figure 4: Correlation Between S&P 500 and 10-year U.S. Treasury Returns
0.6

Concern about
Fed QE reduction(taper tantrum)

0.4

Debate about
ECB QE
extensionSpeculation about
Fed tightening

0.2

Focus onglobal policy
tightening

Hawkish Fed
rhetoric

Correlation

0.0
-0.2
-0.4
-0.6
-0.8
-1.0
2011

2012

2013

2014

2015

2016

2017

2018

Axis
Title
Correlations based on daily returns using exponential weighting
witha 40-day half-life over a 1-year rolling window.
Source: Bloomberg; U.S. Treasury.
5

See, e.g., “Inflation Persistence in an Era of Well-Anchored Inflation Expectations” (a Federal Reserve Bank of San Francisco Economic Letter),John C. Williams, October 2006.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors

5

information about the Fed’s policy approach—specifically,days on which the Federal Open Market Committee(FOMC), the policymaking body of the Fed, releases eithera policy statement or the minutes from its meeting.
Relative to the correlation measure shown in Figure 1,
we can see in Figure 5 that the correlation on FOMC
release days shifts notably higher, with strong statisticalsignificance. This pattern suggests, as expected, that
FOMC days contain a larger amount of policy news
(scenario 2 in Table 1) relative to the regular set of
information about the economy and risk attitude(scenarios 3 and 4). 6

The localized dynamics highlighted in this section are
similar in nature to what we believe drove the moregenerally positive correlation before the late 1990s—
when movements in asset prices were heavily influenced
by changes in discount rates that were disproportionately
associated with inflation or policy-related uncertainty.
That dynamic dominated markets in the decades leading
up to the shift in correlation. Now, with low inflation wellestablished and the Fed’s policy approach better
understood, those types of dynamics take place only on amuch smaller scale, and we have to look much moreclosely to find them.

Finally, to zoom the lens in one final step, we can look at
the intraday timing of correlation shifts on those FOMC
days. We do so by measuring the correlation between
equity and bond returns over 5-minute windows during
the applicable day, allowing us to plot the difference in themean intraday correlations that occur on FOMC days
relative to the mean intraday correlations observed on
non-FOMC days. Figure 6 shows that the window of timesurrounding the 2:00 p.m. (Eastern) release of the Fed’s
policy statement is associated with a substantially higher
correlation than observed during the same window on
non-policy days.

Implications for theTerm Premium
We believe that the regime shift in correlation has meaningful
implications for asset prices. From the perspective of a
CAPM-type approach, if investors were convinced thatbonds offered a negative correlation with equity returns,
then they would expect the risk premium on bonds (the“term premium”) to be negative. 7 That is, investors may
be willing to accept a negative expected excess return, in

Figure 5: Stock-Bond Correlation on FOMC and non-FOMC Days
0.2
Non-FOMC Days
0.1

FOMC Days

Correlation

0.0
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
2005

2007

2009

2011

2013

2015

2017

Correlations based on a regression of S&P 500® returns on 10-year U.S. Treasury note returns, with a dummy variable included
for days with the release of FOMC statements or minutes. The regression uses exponential weighting with a 2-year half-life.
Source: Bloomberg; Federal Reserve Board.
6

The only exception over the sample was in 2008; we believe this exception is attributable to the breakdown in a significant number of market
relationships during this period.

7

The Capital Asset Pricing Model (CAPM) relates the expected return of an asset to the systematic risk embedded in that asset, where thesystematic risk is measured by the sensitivity of its returns to those of the overall market.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors6effect paying for the hedging services offered by bonds. If
those bonds had particularly good payouts during periodsof financial crisis or at other times when “insurance-like”
payouts are highly valued, that would further support anegative sign on the term premium.
Of course, risk premia are more complicated thansuggested by CAPM and are a function of a number ofother factors, including the supply of an asset, captive
demand for an asset generated by regulatory requirements
or liability structures, and changes in the risk tolerance ofinvestors. But even with these generalizations, it follows
that the shift in the correlation should have contributed toa notable decline in the term premium in recent decades.
Measuring the risk premium on bonds is challenging, justas it is for any other asset. Market participants haveincreasingly gravitated towards two models of the term
premium estimated by Federal Reserve staff members: theAdrian-Crump-Moench (ACM) model and the Kim-Wright(KW) model. 8 We rely on those models in our discussion.
Figures 7a and 7b show the history of these estimatedterm premium measures for 2-year and 10-year U.S. Treasury
securities, respectively. These measures represent theannualized expected excess return that an investor would

earn by holding a long position in the applicable Treasury
security on a held-to-maturity basis, relative to the path ofrolling over an investment earning the short-term interest
rate (such as the repo rate or a bill yield). As we can see,
the term premia on these instruments have decreased
meaningfully over the sample period, reaching negative
levels in recent years.
One interesting observation is that the decline in the term
premium has been a gradual process, whereas the shift incorrelations took place relatively quickly in the late 1990s.
This pattern may reflect that market participants needed aperiod of time to become convinced that the correlation
between equity and bond returns had become negative inan enduring manner.
Even if one accepts the shift in the correlation as a primary
driver of the decline in term premia over the sample
period, at least one anomaly remains unexplained: the factthat the expected excess return of holding instrumentswith longer maturities has held its ground to a muchgreater extent. That pattern can be seen by investigating
the shape of the yield curve in more detail at maturities
beyond ten years.

Figure 6: Difference Between Mean Intraday Correlation on FOMC and non-FOMC Days
0.3

Correlation Difference

Release of Fed
Policy Statement
0.2

0.1

0.0

-0.1
99 AM
a.m.

10 a.m.
AM
10

11 a.m.
AM
1112p.m.
PM
12PM
11 p.m.

PM
22p.m.

PM
33 p.m.

Time of Day (Eastern)
Correlations based on returns in each 5-minute interval of futures contracts on the S&P 500® and 10-year U.S. Treasury note.
The figure shows the difference, and standard error of the difference, in mean correlation on FOMC days (days of FOMC
statements) and non-FOMC days since January 2011. The sample includes 68 FOMC days and 1,852 non-FOMC days. Source:
CME Group; Chicago Board of Trade (CBOT); the D. E. Shaw Group.

8

See https://www.newyorkfed.org/research/data_indicators/term_premia.html for a description of the ACM model, andhttps://www.federalreserve.gov/pubs/feds/2005/200533/200533abs.html for a description of the KW model.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors7

In particular, at horizons beyond those at which monetary
policy might change, we can look at the slope of theforward rate curve as an approximation of the expected
return on that instrument. For example, the difference
between the 15y5y forward rate (i.e., the 5-year rate for aperiod starting 15 years from now) and the 10y5y forward
rate will approximate the expected return from holding(receiving) the 15y5y rate for five years, once we make atechnical adjustment for convexity effects. 9
As we can see in Figure 8, the forward rate curve at these
longer horizons has exhibited a positive slope, typicallyof about ten basis points per year. Moreover, this measuredoes not exhibit the persistent decline that was evident in
the shorter-end term premium measures from Figure 7. 10

Figure 7a: Estimate of 2-year Term Premium
2.0%
ACM
Kim-Wright

1.5%

Term Premium

1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
-2.0%
1994

1997

2000

2003

2006

2009

2012

2015

2018

Source: Bloomberg.

Figure 7b: Estimate of 10-year Term Premium
4.0%
ACM

Term Premium

3.0%

Kim-Wright

2.0%
1.0%
0.0%
-1.0%
-2.0%
1994

1997

2000

2003

2006

2009

2012

2015

2018

Source: Bloomberg.
9Note that we have switched to looking at the returns on forward rates rather than bonds. One can think of holding a longer-term bond as
roughly equivalent to holding a shorter-maturity bond and a forward rate that spans the difference in maturities. (For example, holding a 15-yearbond conceptually involves holding a 10-year bond and receiving a 10y5y forward rate.) By focusing on the forward rate, we are able to consider
the portion of the expected return on the bond that is not associated with that of the shorter-maturity bond.

10

Here we are considering the expected excess return to holding the forward rate over a particular period, such as five years. The term premium
measures shown earlier are the expected excess returns to holding securities to maturity. It is possible for the forward rate to have positive
expected excess return over the near term and yet a negative held-to-maturity term premium, if the average returns of the security are expected
to turn negative as the starting point of the forward rate approaches.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors

8

Figure 8: Rolldown for Longer-Term Forward Rate
0.4%

Annualized Rolldown

0.3%

0.2%

0.1%

0.0%

-0.1%

-0.2%
1994

1997

2000

2003

2006

2009

2012

2015

2018

Annualized rolldown over 5 years for the 15y5y forward rate based on interest rate swaps and adjusted for convexity effects.
Source: Bloomberg; the D. E. Shaw Group.

So what might explain this anomaly? It seems reasonable
that shorter and intermediate maturities would embed themost negative levels of the term premium. After all, those
are the maturities at which interest rates are most strongly
influenced by the expected reaction of monetary policy
to shifting economic growth prospects, and they may also
benefit disproportionately from the “flight-to-quality”
dynamic that manifests during periods of market stress.
By contrast, at longer maturities, there may be greater
scope for rates to be driven by other factors that might
not induce the same negative correlation with stock prices.
Nevertheless, given the increased stability of long-term
inflation expectations since the 1990s, the correlation
properties of distant forward rates have also become morefavorable, and hence one might expect their risk premium
to have declined to some degree.

What Lies Ahead?
It is difficult to fathom how great an impact the shift to anegative stock-bond correlation has had on global financial
markets over the past 20 years.
The negative correlation has sharply increased the hedging
utility of bonds to investors in their efforts to constructdiversified portfolios. Indeed, if investors were pursuing asimple mean-variance portfolio optimization with juststocks and 10-year bonds, a shift in the correlation from
0.4 to -0.4 would, with unchanged risk premia, cause
them to more than double their target holdings of bonds. 11
The greater attractiveness of bonds contributed to a massive
repricing of fixed income assets, with the 10-year term
premium declining by around 100 basis points since thelate 1990s. That decline created a remarkable amount of
capital gains for investors in U.S. financial markets, andeven more for global investors if we consider the similar
patterns realized around the world.
Thus, we risk stating the obvious when we say that a lot
rests on whether the regime persists.
Our view is that this meaningful shift in the behavior
and pricing of these assets can largely be traced to one
particular set of institutions: global central banks. The
success of those institutions in anchoring longer-term
inflation expectations and enhancing the predictability ofmonetary policy has, in our view, been a key factor leading
to the shift.
Through that effect, central banks are largely responsible
for bringing the term premium lower over the past several
decades. While market observers have been fixated on the

11
Similarly, the mean-variance optimization would want to boost equity holdings given that the aggregate risk of the portfolio has declined.
However, we leave aside the implications for equity prices in this piece.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors9role of central banks’ quantitative easing (QE) programs indriving down the term premium in the past few years, we
believe that these other aspects of monetary policy haveplayed a much more powerful role in producing thisoutcome over a longer horizon. Indeed, the decline in theterm premium began well before QE was ever put into
place (as can be seen in Figures 7a and 7b).

If we are correct in that view, then we think that the term
premium will remain low relative to its historical levels, andthe decline in term premium could extend even moreforcefully to longer maturities where the adjustment has
been less pronounced. That outcome would represent the
final chapter in the remarkable transition of fixed income
pricing that has transpired over the past two decades.

Under that view, the path of the term premium going
forward rests on whether central banks continue toachieve success along these dimensions. If central banks
were to lose their grip on inflation or allow policy to
become more erratic, we would expect a significant andpainful reversal of the favorable market dynamics thathave characterized the past two decades. The term
premium would likely shift higher, and investors would
face a substantial increase in aggregate portfolio risk, as
stocks and bonds would begin to move together.
However, we believe that a dramatic shift in this directionis unlikely. Our view is that developed economy central
banks will continue to achieve success in keeping inflation
expectations low and stable, allowing the negative
correlations between stocks and bonds to persist for theforeseeable future.
As with any forecast, and especially ones about financial
market behavior over long horizons, our prediction is
subject to meaningful uncertainties and risks. These
include several emerging factors that could posechallenges to central banks, such as potentially unstable
fiscal dynamics in some advanced economies andgrowing pressure on the independence of central banks.
Nevertheless, we believe that central banks have learned anumber of lessons over the past several decades about
the importance of maintaining stable inflation
expectations, and we think it is highly unlikely that thedeveloped world will return to an unmoored inflation
regime similar to those of the 1970s and 1980s. 12

12See, e.g., Marco Vega and Diego Winkelried, “Inflation Targeting and Inflation Behavior: A Successful Story?”, International Journal of Central
Banking, December 2005.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors

10

Appendix
The shift in the stock-bond correlation has been adevelopment not only in the United States, but in almost
all advanced economies. As shown in Figure 9, the timingof the shifts in Germany and the United Kingdom
corresponds closely to the shift in the United States (asseen earlier in Figure 1), but the correlation in Japan clearlyturns negative well before the others.

The earlier shift in the correlation in Japan may be particularly
informative. Japan also reached low levels of inflation
expectations ahead of other advanced economies, and itturns out that the shift in correlation lines up relatively wellwith the decline in inflation expectations, as shown in
Figure 10.

Figure 9: Stock-Bond Correlation in Japan, Germany, and United Kingdom
0.6
Japan
Germany
United Kingdom

0.4

Correlation

0.2

0.0

-0.2

-0.4

-0.6
1990

1994

1998

2002

2006

2010

2014

2018

Correlations based on daily futures returns using exponential weighting with a 2-year half-life. For Japan, data represents TOPIX
and 10-year JGBs; for Germany, DAX and long-term bunds; for United Kingdom, FTSE 100 and long-term gilts. Source: Bloomberg.

Figure 10: Stock-Bond Correlation and Long-Term Inflation Expectations in Japan
0.6

3.0%
Stock-Bond Correlation (LHS)

2.5%

Inflation Expectations (RHS)

0.2

2.0%

0.0

1.5%

-0.2

1.0%

-0.4

0.5%

-0.6
1990

Inflation Expectations

Correlation

0.4

0.0%
1994

1998

2002

2006

2010

2014

2018

Long-term inflation expectations refer to 5y5y CPI expectations. Source: Bloomberg; Consensus Economics.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors

11

Across the three countries, the relationship between thecorrelation and the level of inflation expectations issomewhat harder to measure than it is for the UnitedStates, as the inflation survey data for the pre-1997 period
is more limited. However, there appears to be somepositive relationship across all three countries.

Figure 11a: Stock-Bond Correlation Versus
Inflation Expectations in Japan

Figure 11b: Stock-Bond Correlation Versus
Inflation Expectations in Germany

0.8

0.8
Pre-1997
Post-1997

0.6

0.4

0.2

0.2

0.0

0.0

Correlation

Correlation

0.4

0.6

-0.2
-0.4

-0.2
-0.4

-0.6

-0.6

-0.8

-0.8

-1.0
0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Pre-1997
Post-1997

-1.0
0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Inflation Expectations

Inflation Expectations
Correlations based on daily futures returns for the corresponding
half-year or quarter, as applicable. Data for each country
represents the same instruments used in Figure 9. Source:
Bloomberg; Consensus Economics.

Correlations based on daily futures returns for the corresponding
half-year or quarter, as applicable. Data for each country
represents the same instruments used in Figure 9. Source:
Bloomberg; Consensus Economics.

Figure 11c: Stock-Bond Correlation Versus
Inflation Expectations in United Kingdom
0.8
0.6
0.4

Pre-1997
Post-1997

Correlation

0.2
0.0

-0.2
-0.4
-0.6
-0.8
-1.0
0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Inflation Expectations
Correlations based on daily futures returns for the corresponding
half-year or quarter, as applicable. Data for each country
represents the same instruments used in Figure 9. Source:
Bloomberg; Consensus Economics.

MARKET INSIGHTS | Positively Negative: Stock-Bond Correlation and Its Implications for Investors

12

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