Investment Grade Bonds Behave as Expected During Recent Bout of Market Volatility

The breakdown of the negative correlation between bonds and stocks has been a hot topic in financial circles this year. Typically, when equity markets experience negative price volatility, high quality bonds do well as investors seek out safety. For much of 2018, this has not necessarily been the case. Most asset classes around the globe, including bonds, have had a difficult year. Look no further than the Federal Reserve raising the Fed Funds Rate as the reason most investors are citing for the poor return environment.

For much of 2018, investors have been focused on what a tightening monetary policy environment means for not just bonds but also for global risk assets (think equities). In other words, the rising interest rate environment has presented a challenge to most investors; Specifically, bondholders because rates are rising, and equity holders as liquidity is being drained from the financial system.

Thus far in December however, historic normalcy has taken over. See below for December month-to-date returns through last Friday.

S&P 500 -4.55%

1-10yr UST/Agency 0.56%

1-10yr Municipal 0.45%

1-10yr Corporate 0.38%

*Benchmark Data 11/30/18 – 12/7/18. Bond Indices are ICE/BAML

Why the return to “normal?” In recent weeks, the main focus has been on how late we are in the economic cycle and how things like trade wars can impact the domestic and global economies. The Fed has also hinted that we may be closer to the end of rate hikes than the beginning. This is bond friendly and likely why we’re seeing positive returns so far this month. Moving forward, the Fed will continue to be in focus as investors attempt to understand how much further the FOMC has to go with rate hikes. There is also a renewed focus on the economy as investors assess how much further the economy has to run. What is most likely is that we haven’t seen the end of volatility, and to the extent the volatility stems from economic concerns, high quality bonds should provide the traditional “ballast” that we’ve grown accustomed to over the years.

Source: Bloomberg, ICE/BAML