The classic diversification benefit of bonds hedging stocks relies on a specific economic pattern: growth and inflation moving in the same direction. When they diverge, as in stagflation, both asset classes can decline simultaneously, breaking the negative correlation.
A sustained rise in oil prices presents a dual threat to investors. It can simultaneously increase inflation—hurting bond prices—and slow economic activity—hurting stock prices. This combination, known as stagflation, can cause both key asset classes to fall together.
Not all government bonds offer the same diversification benefits. Shorter-term bonds, like 2-year U.S. treasuries, currently have a stronger negative correlation with equities compared to longer-term 30-year bonds, which markets increasingly view as riskier.