Bonds are regaining popularity as a hedge after disappointing investors for years. With stock markets beginning to drop, there is increased interest in bonds and heightened demand for debt security. This sudden interest reflects a renewed appreciation for bonds, significantly as fears of economic recession grow and expectations of falling interest rates increase their appeal.

The recent stock market downturn, primarily triggered by fears of an economic recession, has altered expectations, leading to a surge in bond performance as rate cut expectations increase. This is a reversal from previous years when rising inflation and Federal Reserve rate hikes led to simultaneous declines in both bond and stock markets. As the S&P 500 lost about 6% in the first three trading days of August, Treasury bonds gained nearly 2%, demonstrating their role as a protective hedge during market chaos.

Historically, bonds were expected to offset losses when stock prices fell. Still, this correlation broke down in recent years, notably in 2022, when bonds failed to provide any protection against falling stock prices. However, the recent stock market declines, driven by recession fears rather than inflation as in the past, have reversed this trend, showing bonds can still serve as effective hedges. Investment strategies that once relied on a mix of 60% stocks and 40% bonds are proving their worth again, demonstrating less volatility and more resilience in the face of market turmoil.

Currently, with inflation better managed and focus shifting towards a potential US recession at a time when yields are still significantly above their five-year average, bonds are again favoured. However, the coming week poses significant risks for bond bulls. Upcoming reports on US producer and consumer prices could signal inflation resurgence, potentially driving yields higher. This shift was hinted at when weekly US jobless claims unexpectedly dropped, easing concerns about weakening labour markets.

Some investors have a different market view. If we can see some, rate cuts will be modest and gradual, maintaining that the environment will still be inflationary, which poses a significant challenge for bonds as a hedge. It is wise to keep the portfolio in cash by investing in money market funds.
On the other side, some investors have a different opinion. With lower inflation and more balanced risks, potentially skewed towards concerns of a more significant economic slowdown, bonds will likely demonstrate more of their defensive characteristics. This perspective suggests cautious optimism that bonds may regain their traditional role of providing stability amid market volatility.