Why Stocks and Treasurys Have Been Rising at Same Time

Normally, stocks and bonds don't go up at the same time. But these days, nothing in the markets seems normal.


When stocks fall—usually in response to bad news—investors flee to the security of US Treasurys. Conversely, when stocks rally in response to good news, investors pull their money out of bonds and take on more risk by owning stocks.

Lately, however, both stocks and bonds have tended to go up together.

"They're really having a stare fight, and I don't know who's going to blink first," says Bill Walsh, president of Hennion & Walsh in Parsippany, N.J.

Experts say there are two factors are work here: a weaker dollar—which makes both US stocks and bonds cheaper for investors—and a change in investor attitude toward owning Treasurys in general.

The weakened dollar is acting as the rising tide lifting all investment boats—making not only stocks and bonds cheaper but many commodities such as oil and gold. Low interest rates hurt the dollar's value, and the market is betting that the Federal Reserve is planning no major changes in monetary policy at least until 2010.

"This dollar carry trade is really flooding into all asset classes and leading to a simultaneous rally across anything—stocks, high-yield bonds, Treasury prices, gold," says Mike Larson, an analyst with Weiss Research. "The Fed is essentially pursuing a policy...of asset inflation. They're doing it by cheapening the currency and by flooding the system with easy money."

While Larson's analysis is echoed by his peers, it doesn't fully explain why investors would buy low-risk assets like Treasurys if there's so much confidence that deflation-fighting will remain the goal of policy makers, in turn boosting higher-return assets like stocks and commodities.

Other market experts float another theory to help explain the stocks-bonds relationship further: Treasurys are being used less as a safe haven and more as a hedge against a stock rally that, despite a 50 percent gain, continues to draw skepticism.

"Things that you would expect to happen are not happening together," says Kathy Boyle, president of Chapin Hill Advisors in New York. "We're at the high end of the range again on the S&P. The volatility is still there. That can be upsetting to a lot of people."

Treasurys appear to be serving as the first step back into the markets for some investors.

Just as the yield on the 10-year Treasury started dropping below 3.40 percent the last week of September, parked cash started coming in from money markets.

Net outflows from money market funds hit $43.17 billion for the week ended Sept. 30, according to data EPFR Global provided to Reuters.

Of that total, bond funds took in a whopping $5.274 billion, $3 billion of which went to government debt funds. The move to government bond funds was "eye-catching," EPFR's global market analyst Cameron Brandt told Reuters.

"The Treasury market is definitely rallying because even though it's not the end of the world, there's still 10 percent unemployment and economic growth could take a long time to get out of this," Walsh says. "The Fed's going to keep interest rates low to spur the economy. That's the way Treasurys trade."

To be sure, the Treasurys trade could be undone should third-quarter earnings season continue the very early trend of surprising to the upside. That might send investors full-fledge back into risk and away from the save haven of government debt.

Yet two of the three bond auctions this week went well, with investors avoiding only the very far end of the yield curve with the 30-year bonds that went up for sale Thursday. Strong demand for Treasurys comes even among a battery of surveys showing investor sentiment improving, the latest being findings from online brokerage TD Ameritrade that showed 45 percent of its clients feeling more bullish about investing.

But investor skepticism also appears to remain healthy as well, so those investors pulling funds out of their money market accounts will be looking for where their cash will be treated best.

"People are just scared. They're worried about valuations, they're worried about another correction," Boyle says. "There's a lot of cautious people out there (saying), 'We've gone up too many days and this is a very fierce rally. We've had such a big run-up, we're due for a correction, so I'm going to park my money.' "