The End of the Hedge

For four decades, the trade was simple: own bonds alongside equities, and the negative correlation bails you out when stocks sell off. Ian Harnett, co-founder of Absolute Strategy Research and former chief strategist at UBS, argues that trade is dead. His case, laid out on a recent episode of Top Traders Unplugged, deserves attention from anyone running a 60/40 book — or anything resembling one.

The Correlation Regime Shift

The core argument is structural, not cyclical. Since the early 1980s, stocks and bonds moved in opposite directions during stress events. The mechanism was clean: equity selloffs triggered flight-to-quality flows into Treasuries, pushing bond prices up and partially offsetting equity drawdowns.

That mechanism requires disinflation as a background condition. When inflation is falling or stable near target, central banks can cut rates into equity weakness. Bonds rally. The hedge works.

Harnett's claim: that background condition is gone. Service-sector inflation in the US still runs 3–4%, even as goods deflation masks the headline numbers. Deglobalization shortens supply chains and raises input costs. Trade weaponization eliminates access to the cheapest labor and capital. None of these forces reverse quickly.

If inflation persists above target, central banks face a bind during the next equity drawdown. Cut rates to support growth, and you risk stoking inflation further. Hold rates steady, and bonds offer no hedge — they just sit there while equities fall. In the worst case, bonds and equities sell off together, as they did in 2022.

The Warsh Fed Wildcard

Harnett flags a specific mechanism that could accelerate the regime break. If Kevin Warsh takes the Fed chair, the administration's preference is clear: lower rates and accelerated balance sheet reduction. That combination — cutting the policy rate while draining reserves via QT — sounds contradictory. It is.

Lower rates ease financial conditions at the front end. Faster QT tightens liquidity at the back end. The net effect on long-duration Treasuries is ambiguous at best, negative at worst. For the 10Y currently at 4.08%, the question is whether rate cuts translate into term premium compression or whether accelerated QT keeps the long end elevated. The 2s10s spread at +61 bps already reflects a curve that has re-steepened from the -189 bps inversion of July 2023 — but that steepening came primarily from front-end rate cuts, not from long-end rallying.

The distinction matters. If the long end refuses to rally during the next easing cycle, the duration hedge fails precisely when portfolios need it most.

What the Data Shows

Pull up the slopes chart on yieldcurve.pro and look at the 10Y-3Mo spread over the past five years. The inversion that began in late 2022 and reached -189 bps in mid-2023 has unwound to +39 bps today. Historically, that normalization would signal "all clear" — the recession either happened or was avoided, and the curve is back to compensating for duration risk.

But Harnett's point is that the normalization is mechanical, not fundamental. The curve steepened because the Fed cut from the front, not because investors bid up long-duration bonds out of confidence. The 30Y at 4.70% sits well above pre-pandemic levels. The term premium the market demands for holding long-duration Treasuries has reset higher, and it may stay there.

Check the regime classification — the Level and Slope dynamics tell the story. A Bear Steep regime (rates rising, curve steepening) is the most hostile environment for the traditional bond hedge. It means bonds lose money and fail to offset equity risk.

Hidden Concentration Risk

Harnett makes a subtler point about diversification theater. Many institutional portfolios added private equity and private credit over the past decade as "alternatives." In practice, both are heavily concentrated in technology. Strip away the GP structure, and a 60/40 portfolio with PE and private credit allocations might be running 70–80% effective tech exposure.

When the diversification you think you have is actually concentration, and the hedge you think you have is actually a correlated position, portfolio risk is materially higher than any model shows.

The Rotation That Hasn't Happened

Despite widespread agreement that we're in a new regime, actual capital rotation remains limited. European banks and basic resources are up 50–60% year-to-date, but these are marginal allocations for most US-domiciled funds. The three conditions Harnett identifies for a real rotation — a weaker dollar, global growth acceleration, and US ROE disappointment — haven't aligned yet.

Meanwhile, BRICS central banks are accumulating gold at levels not seen since the late 1990s, before the inflation-targeting framework became consensus. That's not noise. When the institutions responsible for managing reserve portfolios systematically reduce Treasury holdings in favor of gold, they're making the same bet Harnett is articulating: the old regime is over.

What It Means

If the stock-bond correlation stays positive — and there's mounting evidence it will for as long as inflation runs above 2.5% — the implications are straightforward:

Duration is not a hedge. It's a directional bet.

Portfolios built on negative stock-bond correlation need to find actual hedging instruments — trend-following, commodities, volatility strategies — or accept that drawdowns will be deeper and longer than historical backtests suggest.

The 10Y at 4.08% is not expensive by pre-2008 standards. But if you're holding it as a hedge rather than for carry, Harnett's argument says you're running unhedged equity risk and calling it diversification. The yield curve can tell you a lot of things. What it can't tell you is whether the 40-year correlation regime that made 60/40 work is coming back. The structural evidence says it isn't.