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.
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.