Inflation may be falling, but there are no guarantees this will mean bonds will continue to act as a diversifier away from equity risk, according to the guests on the latest edition of the FT Adviser podcast.
Nathan Sweeney, chief investment officer for multi-asset at Marlborough, said: “We can’t be 100 per cent confident that negative correlation between bonds and equities will come back.
"Quantitative Easing created a world where interest rates were very low, and bonds and equities both rose, then we had a period where they both sold off. But while inflation is falling, QE is being unwound by central banks.
"It is likely the long run rate of inflation could reach 3-4 per cent, and in that world, correlations between asset classes may be positive.”
Hugh Gimber, market strategist at JP Morgan Asset Management, said the key to understanding the future correlation between bonds and equities is to understand which “shock” could impact the economy.
Gimber said: “In the 80s and 90s, before the era of independent central banks, inflation was generally higher than we have become used to and as a result, you couldn’t rely on bonds as a diversifier.
"But whenever a growth shock happened, then the correlations proved to be negative again, bonds became a diversifier. So if inflation is low, then bonds are a diversifier, but higher inflation means you have to think more broadly.”
The third guest, Rupert Thompson, chief economist at Kingswood, said: “There have been 20 year periods where bonds and equities have been negatively correlated, and 20 years where they have been positively correlated. And it is the inflation outlook which determines that.
"My view is that with inflation receding, bonds and equities probably will be negatively correlated, but there will be more volatility along the way.”
You can listen to the podcast by clicking on the link above.