Why US Treasuries Stopped Hedging Stock Market Drops

Key Takeaways

• Before 2000, US Treasury bonds moved in tandem with equities, acting as risky, stock-like assets during stagflationary shocks in the 1970s, 1980s, and 1990s.
• Research by Carolin Pflueger with Harvard economists John Campbell and Luis Viceira shows that bond-equity correlation turns positive whenever economic recessions stem from supply shortages rather than demand drops.
• Between 2000 and 2020, demand-driven downturns kept inflation low, which made Treasuries an effective hedge against equity drawdowns.
• Recent supply chain shocks and sticky inflation have restored the pre-2000 positive correlation, wiping out diversification benefits and pushing term premia higher across sovereign debt.

The Flaw in the 60/40 Portfolio

For two decades, modern financial planning operated on a simple rule: when stocks fall, Treasuries rise. Wealth managers built 60/40 portfolios around it, and founders managed cash reserves believing sovereign debt was an ironclad hedge.

Carolin Pflueger explains that this safety was an accident of timing.

“Treasury bonds were not always safe, historically,”▶ 23:47 Pflueger notes. “So there were periods, especially during the '70s, '80s, and '90s, when Treasury bonds were viewed as quite risky.”▶ 23:50

During the late twentieth century, holding government paper did not protect investors from equity drawdowns. When oil crises and wage spirals hit the economy, bonds lost purchasing power right alongside falling corporate margins. Both asset classes dropped together, leaving investors exposed.

Supply Shocks vs. Demand Recessions

The direction of the stock-bond correlation depends on the type of economic shock hitting the market.

“In the 1980s, stagflation was the thing that everyone was talking about,”▶ 27:26 Pflueger says. “If you have a stagflation and you hold nominal bonds, that's terrible, because they become worth less. The recession is terrible for stocks, so then they move together and bonds are risky.”▶ 27:30

Everything shifted after 2000. Recessions in 2001 and 2008 were demand shocks. When consumers cut spending, price pressures vanished. The Federal Reserve slashed interest rates to support the economy, which caused bond prices to rally while equities collapsed.

As Pflueger points out: “Post-2000, recessions tended to be more of the demand variety, which means also that recessions tended to be lower inflation, and so nominal bonds benefit from low inflation.”▶ 27:41

That twenty-year era convinced an entire generation of investors that Treasuries always hedge stocks. But as Pflueger demonstrated in a paper with Harvard economists John Campbell and Luis Viceira, the pre-2000 regime is back. Supply constraints and energy volatility make inflation persistent during downturns. When inflation rises during a slump, the Federal Reserve cannot cut rates without stoking prices. Bonds drop with stocks, destroying the hedge.

The Higher Yield Spread Era

When Treasuries stop acting as insurance, buyers demand extra yield to hold long-term government debt. This surge in term premia resets borrowing costs across the economy.

For venture-backed startups and growing companies, this dynamic changes capital allocation. The discount rates applied to long-dated tech earnings will remain higher because investors can no longer treat government bonds as risk-free portfolio shock absorbers. If inflation remains erratic, bond yields will stay structurally elevated.

What to Do With This

Audit your company cash policy this week. If your startup holds long-duration Treasury bond ETFs assuming they will rise during an equity market crash, sell them and move that capital into short-dated T-bills or cash equivalents. Do not take on duration risk expecting a hedge that only works in demand recessions.