The traditional correlations between some asset classes went haywire in April. Our analysts Serena Tang and Vishy Tirupattur discuss whether, in this environment, investors still consider U.S. Treasuries and the U.S. dollar to be reliable ports in a storm.
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Serena Tang: Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's Chief Cross Asset Strategist.
Vishy Tirupattur: And I'm Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist.
Serena Tang: Today's topic, how investors' perceptions of safe havens are evolving, the impact on correlation between asset classes, and what all this means for your portfolio.
It's Wednesday, May 7th at 10am in New York.
April was a really challenging month, and some market moves were highly unusual. There was also a lot of investor concern whether U.S. Treasuries would continue to be a safe haven. In fact, this became one of the biggest market debates over the last few weeks.
Vishy, let's start here. Prior to this recent sell off, foreign investors looked at U.S. assets as a safe haven. Why is that? And is it still the case now after this turbulent month?
Vishy Tirupattur: So, Serena, if you just step back and look at it, U.S. enjoyed positive growth differentials and positive yield differentials with developed markets in the rest of the world. On top of that, there was a consistent policy – not necessarily infallible policy – but there's a consistent policy with a clear sense of demarcation between the executive and the central bank.
All of this meant U.S. was a very attractive destination for foreign investor flows. Not only during periods of normalcy where U.S. equities really attracted inflows and performed really well, but also during the periods of economic stress; where even periods where the stress was coming from the U.S. itself, such as the Global Financial Crisis. This correlation between bonds and stocks held and U.S. Treasuries were the safe haven asset as the single largest and most liquid, and highly negatively correlated asset with risk assets. So that really worked.
What we are now seeing is that growth differential I talked about may no longer be holding. You know, for these [20]25 and [20]26 U.S. and euro area growth basically will converge – and if our economists’ expectations are right, in 2026, euro area will be growing at a faster pace than the U.S.
So, growth differential argument is fading. And there are some questions about the continued Fed independence. So put all these things together. Some investors are beginning to question whether U.S. assets will continue to be safe haven assets.
So let me come back to you Serena. There've been some recent market moves that have been extremely unusual. That's what created all this debate. In some of – a few days in April, during the periods of sell off, we had both stocks and bonds selling off. And it felt like cross-asset correlations have gone totally haywire.
So, can you talk a little bit about which correlations have changed? Which correlations have held up in these sell off?
Serena Tang: What was highly unusual, and I think reflects part of the debate on U.S. as a safe haven, is the correlation between U.S. equities and the dollar. It is very high at the moment, about sort of two standard deviation above the five-year average. While it's not unheard of for FX stocks correlation to be high, it is usually more associated with EM or emerging markets rather than DM or developed markets. As a means, investors now require higher risk premium for holding the equities, which is a risk asset; but also holding the dollar, which again, traditionally is not thought of as a risk asset.
Vishy Tirupattur: So, Serena, how did the correlation between bonds and stocks hold up in this period?
Serena Tang: Surprisingly, the correlation have really, really held up. Stocks and bond return correlation turned very negative during the sell off that we saw, which means that equity losses were actually offset by bond returns. Now, this isn't entirely true across the curve. You saw 2 Year Treasuries being a much effective diversifier than say the 30 Year Treasury. But all in all, I think it means bonds still work as a diversifier.
Now on this point Vishy, how do you think policy will impact asset correlations we've been talking about, as well as the perception of U.S. assets as a safe haven.
Vishy Tirupattur: So, as I said before, positive growth differentials fade, and we have negative growth differential. And if there are continued questions about the Fed's independence, so some of the attraction of U.S. assets, particularly U.S. Treasuries as a safe haven asset, will be challenged. But that challenge hits the practical reality of the size and the scale of the safe haven assets.
So, if you look around, if you add the comparably rated European government bond market and compare that to the U.S. government bond market, the U.S. market is about 10 times as larger. So, more scale, more liquidity, and the ability to deploy capital during the periods of stress is clearly more in the U.S.
So, this is what I would say. The status of U.S. dollar as the global reserve currency and U.S. Treasuries as the global safe haven asset have taken a bit of a ding, but not gone away.
Serena Tang: Vishy, thanks so much for taking the time to talk.
Vishy Tirupattur: Great speaking with you, Serena, as always.
Serena Tang: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.
