The Bond Market is Normalizing

The normalization of bond yields is creating a healthier environment in which both stocks and bonds can perform well despite their recently positive correlation.

• The six-month rolling correlation between the S&P 500 and U.S. investment-grade bonds reached +59%, its highest positive level since 1997, weakening the usual diversification benefit of holding both assets.
• This correlation reflects recent daily co-movements rather than necessarily similar long-term returns, so it does not mean diversification has permanently failed.
• Bonds now offer meaningful income after years of abnormally low rates, while investors are being compensated for taking duration risk and the Federal Reserve has less need to suppress rates artificially.
• The current backdrop resembles the 1990s, when strong economic and earnings growth coexisted with rising rates and stocks and bonds produced far-above-average returns; the 10-year Treasury yield averaged 6.65% during that decade.
• Rising yields today are being supported by record-setting profit growth and stronger-than-expected consumer spending, while 10-year breakeven inflation expectations have risen only 10 basis points in 2026 and remain anchored.

Takeaway: Higher rates appear to be moving toward historically normal levels rather than signaling a 2022-style inflation shock; if growth remains strong, bonds can provide income, and if growth weakens, falling yields can support bond prices and risk assets, although the rate level that would restrict growth remains uncertain.