Explaining the Stock-Bond Divergence

Global bond yields have edged higher in recent days, but remain well below pre-Brexit levels. In contrast, equity prices have recouped most of their losses, with some stock markets now trading above pre-Brexit levels (Chart 1).

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Three main forces have pulled down bond yields since the vote:

  1. Weaker growth: The Brexit vote has weighed on global growth prospects, particularly in the U.K., but to some extent in Europe and Japan as well. This has caused markets to push out rate hikes further into the future in all the major economies. A more subdued growth outlook has also pushed down inflation expectations, leading to a further flattening of yield curves.
  2. Heightened political uncertainty: there is a strong correlation between the Baker, Bloom, and Davis Policy Uncertainty Index and the 10-year Treasury yield. This is not surprising given that safe-haven bonds tend to benefit from increased political risk.
  3. More dovish central banks: Investors increasingly think that central banks will lean towards greater monetary accommodation in the wake of the vote.

Chart 1

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