Bond-Equity Correlation

The blog for Bank of England staff has shared two interesting articles about bond and equity correlation, which is important in driving investor asset allocation decisions.

Bitesize: 250 years of the bond-equity correlation

By using UK long-term macro data, they firstly show that for most of the 18th-20th centuries, UK government bonds usually behaved like a risky asset. When equity prices fell, bond yields rose, i.e.  bond and equity returns were positively correlated. This correlation was near zero for a prolonged period around the long depression in the late 19th century.

2016_short_mattroberts-sklarSource: Thomas and Dimsdale (2016) and author calculations.
Line shows ten year trailing correlation of monthly returns.

However, according to another paper on this topic (A Century of Stock-Bond Correlations) , since the mid-2000s, US bond and equity returns have been negatively correlated, i.e. bonds became a hedge for risk. And this trend is also apparent in Japan, Australia and UK. One more significant feature is that the correlation turns positive after the end of last century and keeps to be highly correlated recently.




(The correlation tended to increase at times of heightened uncertainty about real economic activity. Japan’s early experience of low inflation is a possible reason why its stock-bond correlation turned positive prior to those in Australia, the United States and the United Kingdom.)

“An important factor underlying the recent, relatively long period of positive correlations has been the considerable and lingering uncertainty created by the global financial crisis, which saw correlations rise in a continuation of the pattern observed during other recessionary periods over the past century.”


The recent positive correlation is also related to central bank policies like QE, though identifying the clear impact of monetary policy on the correlation is difficult given that these programs occurred in response to developments in growth and inflation.


In the blog of Bank of England, they explain change in the neagtive bond-equity correlation in UK Hsince the mid-2000s partly reflects

1.investors being less worried about inflation risks.  <- As well as demand-type shocks being more prevalent than supply-type shocks, the introduction of credible inflation targeting has helped anchor inflation expectations and reduced the likelihood of high inflation risks. Investors may also have become more focussed on bad states of the world.

2.there has been a structural increase in demand for ‘safe assets’, with more investors demanding safe government bonds for reasons unrelated to their expected cashflowsThis has been exacerbated during and since the financial crisis, with deterioration in risk sentiment leading to episodicflight to safety.  And the addition of QE and forward guidance to the monetary policy toolbox may mean long-term bonds react differently to previously.

However, the BOE’s article shows a quite different picture of recent 15 years: the correlation has been, on average, negative since the early 2000s, and the correlation has been much less negative in the past couple of years. The difference may due to the calculation methods.

2016_short_matt_roberts-sklar_2Source: Bloomberg, Bank and author calculations. Lines show one year trailing correlations of weekly returns on 10-year government bonds and equity indices (FTSE All Share for the UK, S&P 500 for the US, DAX for Germany and Topix for Japan). Note: the correlation of equity returns and bond yields would have the opposite sign.

(Consistent with Japan’s ‘lost decade’, the correlation went persistently negative in Japan in the early 1990s, around five years earlier than for the other countries. The correlation for Japan went positive in early 2016 following the introduction of negative rates by the Bank of Japan. Moreover, the newly-introduced long-term yield target should mean Japanese government bonds and equities are uncorrelated going forward.)




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