Strange Interplay between Stocks and Bonds in the Financial Market
A Shift in the Traditional Dynamic
In the financial market, stocks and bonds have long exerted a balancing force on each other. Historically, when the price of one rises, the price of the other tends to fall. Economically speaking, stock prices typically soar during prosperous times, while bond prices climb when the economy faces challenges.
However, recent developments have thrown this traditional structure into disarray. As bond interest rates increase, leading to a decline in bond prices, the stock market often takes a hit or undergoes adjustments alongside it. The primary catalyst for this unexpected correlation appears to be the unprecedented surge in policy interest rates.
Since the emergence of inflation risks following the COVID-19 pandemic, central banks worldwide, including the US Federal Reserve (Fed), have taken drastic measures by implementing interest rate hikes of 0.50% or even 0.75% at a time, as opposed to the more typical 0.25% increments. This cycle of increasing policy interest rates has ensured that the stock market remains inseparable from interest rate trends, especially when the rate increases are substantial enough to impact future valuations based on interest rates.
Interestingly, technology stocks, notorious for their great sensitivity to future expectations, have exhibited particularly volatile price fluctuations compared to their traditional counterparts. This intriguing connection between the stock and bond markets finds confirmation in other indicators as well.
One way to analyze this correlation is by examining volatility indices, commonly referred to as fear indices, in both the stock and bond markets. The Volatility Index (VIX) gauges the volatility of Standard & Poor’s (S&P) 500 Index options and captures the fear experienced by stockholders. The VIX portrays a significant surge when stock prices plummet, while remaining subdued during periods of stock price stability or mild fluctuations.
Similarly, the bond market possesses its own fear indicator called the MOVE index, which measures the volatility of US Treasury interest rates. Bondholders experience fear manifested through this index, where it rises when bond prices fall and falls when bond prices rise.
Comparing the trends of these two indices over the past year reveals a contrasting picture. The stock volatility index (VIX) has demonstrated a steady downward stability, while the bond movement index has witnessed a substantial increase in levels, persisting even until recently. Notably, the index reached an all-time high when Silicon Valley Bank (SVB) faced bankruptcy in March of this year.
Assessing the correlation between the stock and bond markets as responses to fear or risk, it becomes apparent that changes in the bond market and investment sentiments have significantly impacted stock price trends ever since the Federal Reserve embarked on its policy rate hikes in 2022. Notably, the Movement index has risen significantly, reflecting the mounting fear among investors. Consequently, this has exerted a substantial influence on the adjustment movements of stock prices, distinguishing it from the relatively stable trend observed in the stock market volatility index.
In addition to the conclusion that the rise in policy interest rates has led to volatile movements in both stocks and bonds, we must embark on a process of estimation to identify the epicenter of fear within the overall financial market’s recent increase in volatility.
As we seek to comprehend the underlying cause behind this shift, it is becoming evident that the extraordinary interplay between stocks and bonds demands further scrutiny.
Generally, in the financial market, stocks and bonds keep each other in check. This is because when the price of one side rises, the price of the other side tends to fall. From an economic point of view, which is the easiest to explain, stock prices only rise when the economy is good, while bond prices only rise when the economy is bad. Even when the same economic indicators are released, bonds are sensitive to negative aspects like ‘children of darkness’, while stocks try to communicate positivity and hope. However, strange signs of change in this traditional structure have recently appeared in the financial market. This is because as bond interest rates rise (bond prices fall), the stock market often takes a hit or adjusts along with it. The reason we can think of right now is that this increase in policy interest rates is the biggest ever. As inflation risks have emerged since COVID-19, global central banks, including the US Federal Reserve (Fed), have raised interest rates noisily by 0.50% point, or even 0.75% point on per time, instead of the current 0.25% point increases ■ A cycle of increases in policy interest rates has been implemented. The stock market was also never free from interest rate trends as interest rate increases were steep enough to change the valuation that converts future value based on interest rates. It is in this context that technology stocks, whose stock prices react relatively sensitively based on future expectations, showed very sensitive price volatility compared to traditional stocks. The recent strange connection between the two markets is also confirmed by other indicators. What you can think of is a way to compare volatility indices, the so-called fear indices, in the stock and bond markets. The Volatility Index (VIX) is an index created based on the volatility of Standard & Poor’s (S&P) 500 Index options, and as mentioned earlier, is a form of fear felt by those who own stocks . The index rises significantly when stock prices fall, and remains muted when stock prices rise or move sideways. If the stock market has a volatility index, the bond market has a MOVE index. This index, created based on the volatility of US Treasury interest rates, represents the fear felt by bondholders, just like the volatility index. In general, when bond prices fall, the MOVE index rises, and when bond prices rise, the index falls. Comparing the trends of the two indices since last year, the stock volatility index (VIX) has stabilized steadily downwards overall, while the level of the bond movement index has increased significantly compared to the front and has not been dropping much until recently. When Silicon Valley Bank (SVB) went bankrupt in March this year, the index hit an all-time high. If we evaluate the correlation between the stock and bond markets as a reaction to fear or risk, it can be concluded that changes in the bond market and investment sentiments have had a significant impact on stock price trends since the Federal Reserve began raising policy rates in 2022. possible. Compared to the stock market volatility index, which showed a relatively stable trend, the Movement index rose significantly, reflecting the increase in fear, and as a result, it can be seen that it had a significant impact on the adjustment movement of stock prices . In addition to the conclusion that bonds and stocks show volatile movements as a result of aggressively raising policy interest rates to stabilize prices, this is a process of finding the cause of the recent increase in volatility in the general financial market through the process of estimation. where there is an epicenter of fear. Daishin Securities Economist and Bond Analyst
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