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How bonds, stocks, the dollar and commodities connect

You can explain the usual links between interest rates, bonds, shares, the US dollar and commodities, and why these links change with the economic regime.

When both fall

A classic balanced portfolio holds shares and high-quality bonds. The idea: when shares fall in a crisis, bonds often rise and soften the blow.

In 2022 that did not work. Shares and bonds fell together, and many investors had their worst year in decades. Understanding why requires looking at how markets connect, and at the one variable that links them all: interest rates.

Rates link all markets

Studying these links is called intermarket analysis. The central link is the expected path of interest rates, which depends mostly on growth and inflation.

Bonds. When rates are expected to rise, existing bonds lose value, and their yields rise.
Shares. Higher yields raise the discount rate for future profits and offer a competing return. Slower growth lowers the profits themselves.
The US dollar. Money tends to flow toward the currency whose rates are rising relative to others.
Commodities. Many are priced in dollars. A stronger dollar makes them more expensive in other currencies, which can weigh on demand. Supply shocks can override this.

The links depend on what worries markets most:

Growth scare: rates are expected to fall. High-quality government bonds often rise while shares fall. This is the classic risk-on, risk-off pattern: in risk-off phases, money moves from riskier assets into safe havens.
Inflation scare: rates are expected to rise. Bonds and shares can fall together.

2022: inflation regime

2022 was an inflation year. US inflation reached its highest level in about four decades, and the Fed raised its policy rate from near zero to 4.25% to 4.50% within nine months.

The S&P 500 price index fell 19.4%.
The Bloomberg US Aggregate bond index fell about 13%, its worst year since it was created in 1976.
Gold futures ended the year almost unchanged.
The US dollar index rose about 8%, as US rates rose faster than most others.

The same portfolio that bonds had protected in growth scares was hit twice. Energy commodities, meanwhile, were driven mainly by supply: Russia's invasion of Ukraine pushed oil and gas prices up in the first half of the year, regardless of the dollar.

Common mistakes

Treating correlations as permanent. The link between stocks and bonds has changed sign more than once.
Expecting the dollar to explain every commodity move. Supply and demand of the commodity itself often dominate.
Ignoring the regime. Ask whether markets fear slower growth or higher inflation.
Assuming diversification protects every year. In some years, most assets fall together.

The takeaway

Rates link all markets: bonds, shares, the dollar and commodities react to growth and inflation. The links change, as 2022 showed.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the one that rose in 2022 while stocks and bonds fell.

Tap the chart.

The US dollar index rose 8.0% as the Fed raised rates faster than most other central banks.
2Why did bonds fail to protect stock portfolios in 2022?

When inflation is the main worry, rate fears can hit both. In growth scares, high-quality bonds have often risen while shares fell.
3What does risk-on, risk-off describe?

In risk-off phases, money tends to move from shares and higher-yielding currencies into perceived safe havens.
4Why are many commodities priced in dollars sensitive to the dollar?

It is a tendency, not a rule. Supply shocks, such as in energy in 2022, can dominate.

of 4 correct.

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