U.S. Treasurys at ‘critical point’: Stocks, bonds correlation shifts as

By Christine Idzelis

‘Slower growth, less inflation, that’s good for bonds,’ says Charles Schwab’s chief fixed-income strategist

Bonds and stocks may be getting back to their usual relationship, a plus for investors with a traditional mix of assets in their portfolios amid fears that the U.S. faces a recession this year.

“The bottom line is the correlation now has shifted back to a more traditional one, where stocks and bonds do not necessarily move together,” said Kathy Jones, chief fixed-income strategist at Charles Schwab, in a phone interview. “It is good for the 60-40 portfolio because the point of that is to have diversification.”

That classic portfolio, consisting of 60% stocks and 40% bonds, was hammered in 2022. It’s unusual for both stocks and bonds to tank so precipitously, but they did last year as the Federal Reserve rapidly raised interest rates in an effort to tame surging inflation in the U.S.

While inflation remains high, it has shown signs of easing, raising investors’ hopes that the Fed could slow its aggressive pace of monetary tightening. And with the bulk of interest rate hikes potentially over, bonds seem to be returning to their role as safe havens for investors fearing gloom.

“Slower growth, less inflation, that’s good for bonds,” said Jones, pointing to economic data released in the past week that reflected those trends.

The Commerce Department said Jan. 18 that retail sales in the U.S. slid a sharp 1.1% in December, while the Federal Reserve released data that same day showing U.S. industrial production fell more than expected in December. Also on Jan. 18, the U.S. Bureau of Labor Statistics said the producer-price index, a gauge of wholesale inflation, dropped last month.

Stock prices fell sharply that day amid fears of a slowing economy, but Treasury bonds rallied as investors sought safe-haven assets.

“That negative correlation between the returns from Treasuries and U.S. equities stands in stark contrast to the strong positive correlation that prevailed over most of 2022,” said Oliver Allen, a senior markets economist at Capital Economics, in a Jan. 19 note. The “shift in the U.S. stock-bond correlation might be here to stay.”

A chart in his note illustrates that monthly returns from U.S. stocks and 10-year Treasury bonds were often negatively correlated over the past two decades, with 2022’s strong positive correlation being relatively unusual over that time frame.

“The retreat in inflation has much further to run,” while the U.S. economy may be “taking a turn for the worse,” Allen said. “That informs our view that Treasuries will eke out further gains over the coming months even as U.S. equities struggle.”

The iShares 20+ Year Treasury Bond ETF (TLT) has climbed 6.7% this year through Friday, compared with a gain of 3.5% for the S&P 500 , according to FactSet data. The iShares 10-20 Year Treasury Bond ETF (TLH) rose 5.7% over the same period.

Charles Schwab has “a pretty positive view of the fixed-income markets now,” even after the bond market’s recent rally, according to Jones. “You can lock in an attractive yield for a number of years with very low risk,” she said. “That’s something that has been missing for a decade.”

Jones said she likes U.S. Treasurys, investment-grade corporate bonds, and investment-grade municipal bonds for people in high tax brackets.

Read:Vanguard expects municipal bond ‘renaissance’ as investors should ‘salivate’ at higher yields

Keith Lerner, co-chief investment officer at Truist Advisory Services, is overweight fixed income relative to stocks as recession risks are elevated.

“Keep it simple, stick to high-quality” assets such as U.S. government securities, he said in a phone interview. Investors start “gravitating” toward longer-term Treasurys when they have concerns about the health of the economy, he said.

The bond market has signaled concerns for months about a potential economic contraction, with the inversion of the U.S. Treasury market’s yield curve. That’s when short-term rates are above longer-term yields, which historically has been viewed as a warning sign that the U.S. may be heading for a recession.

But more recently, two-year Treasury yields caught the attention of Charles Schwab’s Jones, as they moved below the Federal Reserve’s benchmark interest rate. Typically, “you only see the two-year yield go under the fed funds rate when you’re going into a…