Today, we are fortunate to have Willem Thorbecke, Senior Fellow at Japan’s Research Institute of Economy, Trade and Industry (RIETI) as a guest contributor. The views expressed represent those of the author himself, and do not represent those of RIETI, or any other institutions with which the author is affiliated.
The US government debt is equal to $38 trillion. In fiscal year 2025 the government paid off nearly three trillion dollars in federal debt. This is more than what the government spent on defense. Interest payments on the debt have more than doubled since 2021.
Risk Characteristics of Treasury Bonds
Interest rates on Treasury bonds depend on their risk factors. Financial theory teaches that the risk of an asset depends on its correlation with the stochastic discount factor (SDF). Assets with a high negative correlation with SDF pay less in risky periods when SDF is high. To compensate for this risk they must pay higher expected returns. Stocks have a negative correlation with SDF so they should offer higher expected payouts. Campbell et al. (2025) treated the correlation of other assets and stocks as a proxy for their correlation with SDF. So if covary bonds are convinced of risky stocks and should offer higher interest rates.
Following Campbell et al. (2025), we can investigate bond stock sales by regressing the return on long-term Treasury bonds on the returns of the US aggregated stock market. Figure 1 presents the results of regressing returns on 10-year Treasury securities on returns for the Standard and Poor’s 500 stock market index. The estimate is made using daily data over 90-day windows between 1981 and 2025. The figure shows all components where beta is statistically significant at least at the 10% level. Bond-stock movements were particularly positive during the 1980s and 1990s. They became negative towards the end of the century. They remain negative until the third quarter of 2022. They again turned positive between 2022Q3 and 2024Q2.
Pflueger (2025) investigated the causes of bond-stock comovements using the New Keynesian model. He estimated the model twice, one focused on the 1980s and the other after 2000. In the first period, supply shocks were volatile and monetary policy was anti-inflationary. In the second period, demand shocks became stronger, supply shocks became secondary, and monetary policy put less weight on fighting inflation. Consistent with historical data, his model produced positive bond-stock movements in the first period and negative movements in the second period.
Pflueger (2025) also used a fictitious scenario to try to find bond stock payouts using valuations from the 2000s. He reported that supply shock volatility is necessary but not sufficient to generate large bond stock betas as occurred in the 1980s. Monetary policy should also give more weight to inflation. Naturally, if monetary policy makers reduce the rate of inflation and allow real interest rates to fall following a negative supply shock, the economy will avoid recession. Therefore, while bond prices fall due to inflation, stock prices do not fall because monetary policy slows down output. On the other hand, if monetary policy makers are hawkish, higher inflation due to negative supply shocks will be accompanied by higher real interest rates and lower output. Higher inflation reduces bond returns and lower yields reduce stock returns. That way stock and bond prices will move together.
Figure 1 shows that, in addition to the positive correlation in the 1980s and the negative correlation in the 2000s that Pflueger (2025) investigated, bond-stock betas were positive and large in 1994 and 1995. And they were good between 2022Q3 and 2024Q2. The 1994-1995 period was a time when tight monetary policy dominated the bond market (see Campbell, 1995). The period 2022-2024 was the period when the Russia-Ukraine war, expansionary fiscal and monetary policy, and other factors pushed inflation to a 40-year high. The Fed then responded with an aggressive tightening policy. These episodes highlight how inflationary shocks and anti-inflationary monetary policy can trigger stock bond yields.
Investigating Bond-Stock Movements Since the 1960s
Campbell et al. (2025), Pflueger (2025), and others investigate bond-stock movements since the 1970s. One reason for the initial date is that data on the 10-year Treasury yield are available from Gürkaynak et al. (2007) from the 1970s. In the 1970s bond-stock movements were positive, meaning bonds were risky. Thorbecke (2026) has explored these discussions since the 1960s. In the 1960s Treasury bonds were considered safe, the assets of choice for widows and orphans.
7-year Treasury coupon rate data is available from Gürkaynak et al. (2007) from the 1960s. These 7-year yields are closely related to 10-year yields. Regressing the 7-year yield change on the 10-year yield change for the period August 1971 to November 2025 gives a coefficient of 0.99 and 455 t-statistics.
Figure 2 shows the effects of regressing returns on 7-year Treasury securities on returns for the Standard and Poor’s 500 stock market index. The estimate is made using daily data over 90-day windows between 1964 and 1980. The figure shows all components where beta is statistically significant at least at the 10% level.
Between 1964Q1 and 1967Q3 the betas are never positive and statistically significant. The beta is negative and statistically significant in 1966Q1. Betas then become positive and significant from 1967Q4. Between 1967Q4 and 1971Q3 the betas are positive and statistically significant in 10 of the 16 quarters.
Understanding the Bond-Stock Movements of the 1960s and 1970s
Although several supply shocks hit the US economy in the late 1960s, President Johnson in 1968 ran the highest budget deficit in more than two decades. The Federal Reserve at this time viewed this deficit as inflation. The rate of consumer price inflation (CPI) rose from 3% in 1967 to 5.5% in 1969 to 6% in 1970. The Fed, after falling behind the curve, fought hard against inflation from late 1967 to late 1969. monetary policy Pflueger (2025) found was necessary to generate bond-stock exchanges.
There are no statistically significant betas in Figure 2 between 1971Q4 and 1974Q2. The rate of inflation came very fast during this period. Grain prices rose as the US government planned the largest grain sale in history to the Soviet Union. The dollar depreciated by 20% between August 1971 and July 1973, driving up import prices. Poor anchovy catches in Peru forced feedstock producers to replace anchovies with soybeans. This combined with flooding in the Midwest has pushed up soybean prices. The drop in food prices was 17% in 1973.
Despite rising inflation, the Fed’s policy remained expansionary. Fed Chairman Arthur Burns believed that the wage and price controls implemented by President Nixon would contain inflation (Pierce, 1979). Burns focuses on economic stimulation.
Oil prices then quadrupled between October 1973 and March 1974. The CPI inflation rate in 1974 exceeded 11%. The Fed in 1974 implemented a tight monetary policy to combat inflation. A combination of inflationary shocks and hawkish monetary policy is associated with a positive beta beginning in 1974.
The second oil price shock came in 1979. It was fueled by the Iranian Revolution and intensified by the Iran-Iraq War. The overall inflation rate in 1980 reached 14%. Fed Chairman Paul Volcker then declared war on inflation. The betas in Figure 2 are larger in 1979 and 1980.
Thorbecke (2026) reported vector autoregression evidence showing that monetary policy contributed to positive bond-stock returns from 1967-71 and increased over the next 15 years. Evidence from cross-sections of asset returns also shows that both monetary policy shocks and inflation shocks drove bond and stock prices in the same direction during this period.
Current Studies
Evidence dating back to the 1960s confirms what Pflueger (2025) found in more recent times. In both cases inflationary shocks combined with hawkish monetary policy produced bond yields. The US government must be careful now not to encourage inflation, whether through tariffs, budget deficits, or other factors. The Fed should also not allow inflation to accelerate as this will require aggressive policy later. Otherwise, the government and the Fed risk making Treasury bonds even riskier than they are now. This would raise interest rates and multiply the Federal debt service costs which are already equal to 1 trillion dollars a year.
References
Campbell, JY 1995. Some Lessons from the Yield Curve. Journal of Economic Perspectives, 9, 129–152.
Campbell, JY, Pflueger, C., and Viceira, L. 2025. Bond-Stock Comvements. NBER Working Paper 34323. Cambridge, MA: National Bureau of Economic Research.
Gürkaynak, R., Sack, B., and Wright, J. 2007. The US Treasury yield curve: 1961 to the present. Journal of Monetary Economics54, 2291-2304.
Pflueger, C. 2025. Back to the 1980s or not? Drivers of Inflation and Real Risks in Treasury Bonds. Journal of Financial Economics167, Title Number 104027.
Pierce, J. 1979. The Political Economy of Arthur Burns. Journal of Finance34, 485-496.
Thorbecke, W. 2026. Bond-stock Price Movements: Evidence from the 1960s to the 1990s RIETI Discussion Paper 26-E-011. Tokyo: Research Center for Economics, Trade and Industry.
This post was written by William Thorbecke.
