The Bond Market Is Normalizing

• Stock-bond correlation hit +59%, the highest since 1997, reducing the traditional diversification benefit where one asset 'zigs' while the other 'zags'
• Unlike 2022's inflation-driven rate hikes, today's rising yields stem from strong economic growth and solid earnings, with long-term inflation expectations rising only 10 basis points this year
• The normalized bond market provides healthy yields during strong growth and has room for yields to fall (prices to rise) if growth weakens, supporting risk asset allocation

Bond Market Normalization Signals Healthier Investment Environment

Key Development: The correlation between stocks and bonds has reached +59%, the highest positive level since 1997, meaning both asset classes are increasingly moving in the same direction rather than providing traditional diversification benefits.

Market Implications:

Despite reduced diversification, this high correlation may indicate strong underlying support for both stocks and bonds. The current environment resembles the 1990s, when similar correlation levels coincided with far-above-average returns for both asset classes despite sharply rising interest rates.

Supporting Factors:

• Bonds now provide meaningful income after years of abnormally low rates, compensating investors for duration risk
• The Federal Reserve faces less pressure to artificially suppress rates to support economic growth
• The economy is absorbing higher rates in ways that appear "normal, healthy, and constructive"
• Growth and earnings outlook mirrors the strong 1990s period

Inflation Context:

The situation differs significantly from 2022's aggressive Fed rate hikes driven by soaring inflation. While oil prices and Iran conflict create short-term concerns, longer-term inflation expectations (10-year breakeven rate) have risen only 10 basis points this year and remain well-anchored.

Historical Perspective:

Current rates are rising from abnormally low levels back toward historical norms—the 10-year Treasury yield averaged 6.65% in the 1990s. In a normalized bond market, bonds deliver healthy yields during strong growth and have room to appreciate if growth weakens, ultimately supporting investor confidence in risk assets like stocks.

Bottom Line: The bond market's return to normalcy creates a healthier environment for risk-taking and capital allocation across both stocks and bonds.