Marcella Chow

Macroscope | Why stocks and bonds are moving in the same direction – down

An increasingly stagflationary environment has reversed the traditional relationship between the two asset classes, with both bond and stock markets struggling amid high inflation, slowing growth, rising interest rates and a hawkish Federal Reserve

Reading Time:3 minutes

Why you can trust SCMP

A trader works on the floor of the New York Stock Exchange on May 19. Photo: EPA-EFE

Marcella Chow

Published: 4:30pm, 20 May 2022

The year so far has been challenging for global markets. Growing concerns about an overly hawkish US Federal Reserve and intensifying growth headwinds in China have led to equity sell-offs while the rise in US Treasury yields has weighed on fixed income markets given the inverse relationship between bond prices and interest rates.

While historically stock and bond performances have tended to move in opposite directions, both asset classes have seen negative returns in the year to date with an increasingly positive correlation.

Much of the downward pressure on equities has stemmed from stickier than expected US inflation. The US April consumer price index has reinforced sentiments that high inflation may persist throughout the next quarter, leading to concerns about the Fed over-tightening as it attempts to tame inflation by increasing interest rates.

Higher interest rates mean increased borrowing costs which cools economic activity by weighing on business capital expenditure and consumer spending, and may further slow down growth. Investors are worried that interest rates may be increased too much too quickly, which could tip the economy into a recession.

After the Fed announced an interest-rate increase of half a percentage point earlier this month, markets expect the Fed funds rate to reach 2.7-2.9 per cent at the end of the year, indicating three more half-point jumps and two more quarter-point increases. Market participants will look for clues in the upcoming meetings, especially the June meeting, to get a better sense of the Fed’s policy plans.

The headquarters of the US Federal Reserve in Washington on May 3. The recent rate increase was the biggest jump in over 20 years. Photo: Kyodo

Having said that, we believe that inflation in the United States can moderate without a recession as the Fed will do its utmost to engineer a soft landing for the country’s economy. Economic growth will inevitably slow this year but inflation should moderate as reopening demand subsides and supply chain pressure alleviates over the course of the year.