Treasury Bonds Risk Losing Safe-Haven Status in a Negative Interest Rate World

August 29, 2019

Source: Bloomberg, ICE BAML 7-10 Year Treasury Index Source: Bloomberg, ICE BAML 7-10 Year Treasury Index

The historical relationship between U.S. Treasury and equity market performance is significant for investors trying to build balanced and diversified portfolios. In this week’s chart, we examine correlation, which measures how two variables fluctuate together. Positive correlation means that variables move in the same direction, while negative correlation indicates that variables move in opposite directions. Stock-bond correlation has varied over time, but has been predominantly negative since 2000. Negative or lowly correlated assets within a portfolio reduce risk and volatility, as losses in one asset class are offset by gains in another.

Stock-bond correlation was mostly positive from the early 1980s until 2000, as both stocks and bonds were in the midst of extended bull markets. Even in this environment, bonds offered valuable diversification when equity markets were in distress (e.g., 1987 stock market crash, 1998 Long-Term Capital Management crisis).

While bonds have offered reliable portfolio diversification to offset equity risk since 2000, investors reaped the greatest benefits of this diversification within their portfolios when they needed it most. Stock-bond correlation dipped below -0.5 (indicating more hedging power for bonds) during the 2000-2002 tech bubble burst, 2007-2008 financial crisis and 2011-2012 European debt crisis.


Key Takeaway

The proliferation of negative yields across the globe has threatened the valuable diversification that high quality bonds have historically offered investors. Market forces are less likely to drive bond valuations as central bank buying propels sovereign bond yields deeper into negative territory. Swiss 10-year government yields at -1.0% are most likely a hedge only against capital preservation for long-term investors. I expect the Federal Reserve will not follow the questionable interest rate experiment in Europe and Japan, but rather help maintain Treasury bonds as an efficient part of portfolio asset allocation.

Tags: U.S. Treasurys | Equity market | asset allocation | Bond yields | Interest Rates

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.

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