In a new FEDS Note, Federal Reserve Board staff find that government bonds’ ability to hedge equity losses depends on the inflation environment and the shocks affecting the economy. When inflation is near target and expectations are anchored, central banks can ease policy in response to weaker growth, supporting bond prices as stocks fall. When inflation is elevated or adverse supply shocks threaten price stability, expectations of tighter policy can cause stocks and bonds to decline together, as occurred during the escalation of the Middle East conflict in 2026. Analysis of the United States, euro area and United Kingdom shows that stock and government bond prices tended to move in opposite directions from 2000 through 2021, when inflation pressures were subdued, but have increasingly fallen together since 2021. Stock-bond correlations turned negative after 2021 in all three markets, including minus 0.09 in the United States, minus 0.02 in the euro area and minus 0.14 in the United Kingdom. The event study also finds that inflation surprises have had a stronger market impact since 2021. Higher-than-expected U.S. inflation now raises U.S. 10-year yields about three times as much as during 2000-2019 and produces larger international spillovers, while domestic inflation surprises weigh more heavily on stock returns. The analysis concludes that the deterioration primarily reflects the inflation and monetary policy environment rather than a permanent change in bond characteristics, suggesting hedging performance could improve if inflation pressures and adverse supply shocks recede.
Federal Reserve Board analysis finds inflation pressures weaken government bonds’ safe haven role
Federal Reserve Board staff find that government bonds lose much of their safe haven value when elevated inflation or supply shocks lead investors to expect tighter monetary policy. Since 2021, stock-bond correlations have turned negative across the United States, euro area and United Kingdom, while bond yields and equities have become more sensitive to inflation surprises. The analysis suggests bonds’ hedging role could recover if inflation pressures and adverse supply shocks diminish.