The exposure of Treasury bond returns to stock market returns: the cases of the U.S. and Spain

The relationship between Treasury bond returns and stock market returns is key to managing risk in classic institutional portfolios. During the past two decades the exposure of the U.S. Treasury bonds to the stock market has been consistently negative providing a high degree of diversification for institutional investors. This negative exposure has been explained by the output-inflation correlation dynamics and the output-supportive focus of monetary policy. Our paper compares the U.S. results with the stock market exposure of Spanish Treasury bonds. Strikingly, the Spanish Treasury bond market beta is mostly positive during the same sample period. The output-inflation dynamics alone does not seem to provide a fully satisfactory explanation for the Spanish market. To understand the positive exposure of the Spanish Treasury bonds to market returns, especially during bad economic times, we need to recognize the fiscal effects of the debt-to-GDP ratio relative to Spanish economic growth.