A Correlation Conundrum Arises for Investors

Data suggest that looser monetary policy helps bonds effectively act as equity hedges, but the Federal Reserve has raised interest rates three times this year, prompting President Trump to implore the Fed to reconsider its tightening trajectory.

Related: Investment-Grade Bond ETFs Aren’t As Popular As They Use to Be

The Federal Reserve’s rising interest rates have been a main contributing factor in the downfall of investment-grade bonds this year. As the Fed hikes the short-term fed funds rate, longer-duration investment-grade bonds with historically low yields have appeared less attractive.

“Things changed around the turn of the century, when both growth and inflation slowed. This allowed for structurally easier monetary conditions. In January of 2000 the fed funds rate was 2.75%. Within 18 months it was barely above the rate of inflation. Since 2002 the real fed funds rate has averaged close to -1%. During this same period, the average stock-bond correlation has been approximately -0.10. In more qualitative terms: A less threatening Fed has allowed bonds to play the role of equity hedge,” according to BlackRock.

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