The normal correlation between long-term interest rates and share prices is positive: they fall in recessions and rise in periods of growth. Markets are moving to a new regime that is dominated not by the economic cycle, but by liquidity. The abundance of liquidity is leading, at portfolio equilibrium, to a rise in both bond prices and share prices, and therefore to a negative correlation between long-term interest rates and stock market indices, per Natixis.
Key quotes
“The correlation between long-term interest rates and share prices is normally expected to be positive. In recessions, risk aversion rises, inflation falls, corporate earnings decline and monetary policy becomes more expansionary. Everything, therefore, works to push down both long-term interest rates and stock market indices. In periods of growth, on the contrary, risk aversion falls, inflation rises, earnings increase, monetary policies become more restrictive and one can expect a rise in long-term interest rates and stock market indices.”
“In the recent period, financial markets have not been dominated by the economic cycle, but by the abundance of liquidity created by the central bank. This liquidity is reinvested in all asset classes, and the result is both a fall in long-term interest rates and a rise in share prices, i.e. a negative correlation between long-term interest rates and share prices. This has been the case since 2019 in the United States and since March 2020 in the eurozone.”
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