Shifting correlations: how trade policy uncertainty alters stock-T-bill relationships

This paper examines how trade policy uncertainty (TPU) influences the correlation between U.S. stock indices and short-term government bonds. The objective is to assess whether policy-related shocks, especially those linked to trade tensions, alter the traditional stock–T-bill relationship and its implications for investors. The authors extend the dynamic conditional correlation (DCC) framework by incorporating exogenous variables to account for external shocks. Three specifications are analyzed: one using the TPU index, one including a dummy variable reflecting presidential-cycle effects and one combining both through an interaction term. The analysis is based on daily data for major U.S. stock indices and the 3-month Treasury bill. Results indicate that TPU exerts a significant effect on stock–T-bill correlations. Moreover, its influence becomes stronger under specific political conditions, suggesting that political agendas can amplify the impact of trade-related shocks on financial markets. Crucially, augmenting the DCC framework with trade-policy-related variables enhances both the statistical fit and the portfolio relevance of correlation forecasts. Therefore, this study contributes to the literature by explicitly integrating policy-related uncertainty into correlation modeling through an augmented DCC framework. The findings provide new insights for portfolio allocation and risk management in environments characterized by heightened trade tensions.