Does the Stock to Bond Allocation Need a New Catalyst?

Stock and Bond prices moved together all last summer and into the fall. But then something happened. But in October the price of Bonds began to fall. What happened at that time? The election was getting close. But we saw that the polls then suggesting Hillary Clinton would win suggested more of the same that had been in place for the last 8 years. This should not have a major impact on bond prices. What had changed was the rhetoric from the Federal Reserve on the state of the economy and the need to remove stimulus. The election was not a catalyst for bond prices to move lower. Rather it was a point of uncertainty that was removes, allowing the FOMC to raise rates, without the prospect of being charged with rigging the election. A funny thought in hindsight.

The passing of the election, and subsequent jawboning by FOMC members moved bond prices lower quickly. It was not long until bonds were down over 10%. But then prices stalled. By mid-December bond returns had flattened. Money continued to move into stocks with returns not reaching 12% until late February. The Fed remains vigilant and at their March meeting raised rates again. But this time Bond prices did not budge. What happened? Are bond investors calling a top in interest rates? In a sense yes.

The chart above shows the quick move lower of bonds in November and then level off, with the rise in equity returns. Without a move in bond prices following the latest FOMC tightening the market is essentially stating that the projected path from the FOMC, or at least the perceived expected path, is the correct path to take. The market agrees with the dot plots. Inflation is being controlled properly and growth is continuing in employment. What will change this not another tightening by the FOMC, but rather a change of pace of tightening, either faster or slower, that disagrees with the market perception. When that happens you will see bond returns move.

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