With a large number of investors flooding into bonds, it's a victory for fund managers who have long been ringing the bell for bonds - and wider asset diversification. This has been an obviously unwelcome suggestion for a long time. Until the stock market started to fall this month, the demand for bond hedging quickly skyrocketed, pushing the yield on 10-year U.S. Treasuries to its lowest level since mid-2023.

This rebound has caught many on Wall Street by surprise.The long-standing relationship between stocks and bonds - a rise in fixed income to offset losses in times of stock market turmoil - has been called into question in recent years.

However, despite the fact that the sell-off at the time was triggered by an outbreak of inflation and the Fed's attempt to curb inflation by raising interest rates, the recent stock market crash was largely triggered by concerns about the economy slipping into recession. As a result, expectations of a rate cut have risen rapidly, and bonds have performed very well in this environment.

The S&P 500 index fell by about 6% in the first three trading days of August, while the U.S. Treasury market rose by nearly 2%.

As the stock market stabilizes in the past few days, bonds will eventually erase most of their gains, but the broader point - fixed income acting as a hedge in moments of market turmoil - remains.

TwentyFour Asset Management portfolio manager George Curtis said: "We have been buying government bonds as a hedge." In fact, Curtis began increasing his holdings of U.S. Treasuries several months ago - partly because yields on U.S. Treasuries are now higher than they were before, and partly because he expects the old stock-bond relationship to return as inflation subsides.

U.S. stock and bond yields are negatively correlated and are returning.

From another perspective, the traditional inverse relationship between these two asset classes - which was basically the case in the early decades of this century - has returned, at least for now.

Last week, the one-month negative correlation between stocks and bonds reached its highest level since the regional banking crisis last year, with a reading of 1 indicating complete synchronous movement of assets and -1 indicating that they moved completely in opposite directions. A year ago, the index exceeded 0.8, its highest level since 1996, indicating that bonds were essentially useless as a portfolio ballast.

With the Federal Reserve's aggressive rate hike from March 2022 leading to two market crashes, this relationship has undergone a dramatic change. The so-called 60/40 investment portfolio lost 17% that year, the worst performance since the global financial crisis of 2008.

Today, the market is back in favor of the bond market, with more control over inflation, and market focus shifting to the possible recession in the United States, while U.S. Treasury yields remain well above their five-year average.

In the next week, investors bullish on bonds will face a lot of risk. The U.S. July CPI and PPI reports are approaching, and any signs of inflation resurgence could push up yields. After initial jobless claims unexpectedly fell this Thursday, yields began to rise, easing concerns that the labor market was weakening. With growing concerns about an economic recession, this data suddenly attracted attention.

Despite the excitement surrounding the bond market today, many, like Bill Eigen, bond fund manager at JPMorgan, remain cautious about getting back into the market.

Eigen manages the $10 billion JPMorgan Strategic Income Opportunities Fund. Over the past few years, he has held more than half of the funds in cash, mainly invested in money market funds such as U.S. Treasuries and other cash equivalents. Short-term U.S. Treasury yields are only slightly higher than 5%, at least a full percentage point higher than long-term bonds. Eigen does not believe inflation is really mild or that the economy is weak enough to warrant Fed easing.

He said: "The degree of interest rate reduction will be small and incremental. The biggest problem for bonds as a hedge tool is that we are still facing an inflationary environment."

However, Bloomberg strategists Ira F. Jersey and Will Hoffman said, "During a recession, the yield curve tends to become steeper. On August 5, the abnormally short-term U.S. 2-year/10-year treasury notes yield curve inversion may signal a steepening trend in bond bulls, and we expect this trend to continue as the economy slows down. At the same time, we believe that the correlation between stocks/bonds may be normalizing."

More and more investors, like Curtis, are putting inflation in a secondary position. During last week's market turbulence, bond investors sent a brief message that their concerns about economic growth are becoming terrible. The U.S. 2-year treasury notes yield for the first time in two years was lower than the U.S. 10-year treasury notes yield, indicating that the market is preparing for recession and rapid rate cuts.

Pacific Investment Management Company Chief Investment Officer Daniel Ivascyn says, "As inflation falls, and risks become more balanced, even with a tendency to worry about economic slowdown, we do believe that the bond market will indeed exhibit more defensive characteristics."