Rates shock (2022)

Definition

In 2022 the Fed raised rates from ~0 to over 4% inside nine months against 40-year-high inflation; the S&P 500 fell ~25%, the Nasdaq ~35%, and — the episode’s defining fact — LONG TREASURIES FELL ~30% ALONGSIDE equities. The classic 60/40 portfolio had one of its worst years on record because its hedge asset failed by construction: in an inflation-driven tightening, the stock-bond correlation flips positive. This is the KB’s living exhibit for regime- conditional hedging.

How it works / structure

• The correlation flip (the load-bearing mechanics): 2000-2021’s negative stock-bond correlation reflected growth-fear regimes (bad news → rate cuts → bonds rally); 2022’s driver was inflation — bad news for bonds WAS bad news for equities (rates up hurt both) — the Campbell-Pflueger-Viceira framework realized out of sample (regime-rate-environments).
• The duration massacre: long-duration assets repriced by discounting arithmetic — 20+ year Treasury funds −30%+, unprofitable-growth equities −60/80% (fa-dcf-valuation duration transmission: the longest cash flows fell hardest, mechanically); value-over-growth factor spreads hit records (strategy-factor-investing regime dependence).
• The event cadence: CPI releases displaced FOMC as the month’s largest event (event-cpi regime-amplitude section documents it — multi-sigma index moves on print days); every asset traded off the inflation path.
• Collateral episodes: the UK gilt/LDI spiral (September — leveraged duration hedgers forced into selling by margin calls on the asset they hedged with) and crypto’s correlation-to-one with risk assets (ext-crypto regime exhibit).

When it applies

Cited whenever bond-hedge assumptions are evaluated (the hedge is regime-conditional — this is the out-of-sample proof); for duration-decomposed equity risk; for inflation-regime event weighting; for allocation stress tests (port-allocation-frameworks — any framework whose backtest window is 2000-2021 embeds the old correlation regime silently).

Risk profile & failure modes

• The central lesson: the diversifying asset’s correlation is a REGIME OUTPUT, not a property — portfolios must state which regime their hedge assumes and monitor the driver (inflation vs growth dominance).
• Backtest-window capture: two decades of negative correlation trained a generation of frameworks (risk parity levered the assumption) — bias-recency at the allocation layer, realized.
• Nowhere-to-hide arithmetic: when the discount rate is the shock, cash is the only short-duration asset — 2022’s best major allocation was the one no framework recommended.
• Misuse: declaring the negative-correlation era dead — the regime flipped WITH its driver; 2023-25 saw partial reversion as inflation fell; the lesson is conditionality, not a new constant.

Evidence & limits

The policy path and market returns are public record; Campbell-Pflueger-Viceira (2020) is the peer-reviewed regime framework the year validated. The gilt/LDI mechanics are Bank of England-documented. Attribution of equity declines between rates and earnings expectations retains the usual decomposition uncertainty.

Falsifiable-thesis examples

Illustrations only, not signals:

• “The 60-day stock-bond correlation stays positive while trailing CPI exceeds 4% (regime-driver thesis)” — falsified by the paired series.
• “This portfolio’s stress test includes a both-assets-down −20%/−15% year and survives its drawdown budget (2022-floor audit)” — falsified by the scenario computation.

Cross-references

• The framework it validated: regime-rate-environments, macro-inflation-linkages
• The transmission: fa-dcf-valuation (duration), ext-bonds-rates, strategy-factor-investing
• The allocation lesson: port-allocation-frameworks, bias-recency
• The event cadence: event-cpi; the sequel: episode-banking-stress-2023