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Good morning. The biggest story in markets at the moment is the fall in Treasury yields. The 10-year has gone from 3.5 per cent to under 3.1 per cent since last Tuesday. The simplest explanation is that recession fears are ascendant, and the market thinks the Federal Reserve will be able to stop tightening (or will be scared into stopping?) at a lower level than previously expected. The futures market is indeed pricing in a lower peak for the fed funds rate. Because the economic data is equivocal, it is hard to know whether this is a jittery overreaction, set for a reversal, or whether we might have seen the peak in long yields. We tend to favour the former, without much confidence.
What, if anything, comes after 60/40?
A year ago, with core inflation (excluding food and energy) at a mere 4 per cent, we showed you this chart from UBS, comparing rolling 36-month core inflation against 36-month stock/bond correlations:
When core inflation rises above 2.5 per cent and stays there, stock and bond returns correlate. When that happens, the core premise of the 60/40 portfolio — when your stocks falter, your bonds will rise — looks shaky. And so it has turned out. With 36-month core inflation now at 3.1 per cent, the 60/40 portfolio has done historically badly.
This is old news. But it comes at an interesting moment. There is a plausible case that inflation will eventually moderate — and another plausible case that inflation is now structurally higher. If the latter proves true, the 60/40 portfolio can no longer be the default — what you might call the “dumb…