The U.S. economy has undergone a fundamental structural shift where supply constraints are now the dominant threat, prompting a stark warning from the Federal Reserve Bank of San Francisco that policymakers may soon grapple with "elevated inflation" alongside weakened economic growth.
A Historic Shift in Financial Markets For the first time in decades, the relationship between equities and government debt has abruptly reversed.
According to a newly released Economic Letter by San Francisco Fed researchers Thomas Mertens and Wesley Wasserburger, the "stock-bond correlation recently flipped, suggesting that the perceived source of risk to the economy has shifted towards supply shocks." During much of the 2000s and 2010s, economic risks largely stemmed from the demand side, leading to a positive co-movement between stocks and bonds.
However, recent supply-side disruptions—such as the COVID-19 pandemic, geopolitical conflicts in Europe and the Middle East, and expanded tariff policies—pushed this correlation into negative territory in the early 2020s.
In a supply-driven environment, scarce goods weaken economic activity and lower stock valuations, while simultaneously raising inflation and pushing bond yields higher.
