Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 421

US rate rises would challenge multi-asset diversified portfolios

The Reserve Bank of Australia (RBA) Board surprised the markets at its August meeting by continuing with the scheduled reduction in bond purchases announced in July. It had been thought that the COVID-induced lockdowns and inflation outlook would push the Board into formalising a delay. The relative sanguinity of the RBA Board can be attributed to a number of factors.

First, as the RBA Governor noted in his statement “the experience to date has been that once virus outbreaks are contained, the economy bounces back quickly”. Additionally, the recovery from the pandemic has to date exceeded expectations.

Second, in the context of what looks to be an interruption to growth from current lockdowns, it is not going to be meaningfully attenuated by delaying for a month or two a decision to taper bond purchases by $1 billion a week from September. Other approaches are more effective.

Third, the Governor noted, the “recent fiscal responses by the Australian Government and the state and territory governments are also providing welcome support to the economy at a time of significant short-term disruption.” Of course, one hopes that such measures are intelligently crafted and targeted. Regrettably that hasn’t always been the case.

Flexibility the key differentiator

Most important is the emphasis given by the RBA to its 'flexibility'. This flexibility is a key differentiator between the RBA and some other central banks who have appeared to foreshadow policy rate increases in 2022. Given the uncertainties ahead, the RBA has done well to avoid any such undertaking, even if it has been of a conditional nature in other jurisdictions.

In other words, if the situation deteriorates the RBA has already communicated that its process allows it to quickly flick the switch and increase bond purchases.

For this reason, it would be a mistake to see the August RBA Board meeting as an indication that the RBA was following the lead of other commodity-intensive economy central banks such as the Bank of Canada, the Norges Bank and RBNZ or even the Fed ‘dot plot’ in indicating a significant retreat from historically high levels of monetary accommodation, including policy rate increases in 2022.

The RBA’s expects that the condition (or ‘outcome’) for any increase in the policy rate “will not be met before 2024".

In this context, the RBA is best viewed as a ‘caged dove’ (a 'dove' is defined as a central banker who generally favours easy monetary policy).

That will likely persist, at least until the RBA gets some clarity on the US Federal Reserve’s (the Fed’s) approach. It is the Fed’s approach to inflation that looms large as a challenge for investors.

Certainly the Fed has commenced “talking about talking about” tapering, and strong economic data and clear inflation pressures are likely to escalate that chatter turning the Fed into a ‘reluctant hawk’ (and 'hawks' generally favour tighter monetary policy).

Investment portfolio diversification

It may be for investors that any escalation of tapering talk, particularly given clear and present inflation danger, necessitates a questioning of portfolio diversification practice, including the assumed negative return correlation between bonds and equities.

As the chart below shows, in the period beginning with the ‘tech wreck’ at the turn of this century, bond and equity returns have been negatively correlated. In essence, once inflation had been purged, any periods of stress in the outlook for economic growth and associated downdraft in equity markets could be quickly addressed by easier monetary policy (lower interest rates and lower bond yields).

However, with bond yields at historic lows, and policy rates approaching the ‘zero-bound’, it is reasonable to question whether yields can go meaningfully lower, particularly given inflation pressures, and what that might imply for the diversification properties of high credit quality nominal government bonds, particularly as long-dormant inflation pressures emerge.

If, in the wake of persistence in inflation, the Fed has to jam down hard on the monetary brakes, leading to sharp upward movements in bond yields, there may well be a significant correction in equity and bond markets.

Multi-asset investing implications

Such a scenario looms as a major challenge for investors, including how multi-asset investors react to a potential reversal of long-held assumptions regarding asset return correlation. That is equity returns and bond returns become positively correlated in the worst possible way  - in extremis, both deliver negative returns.

Clearly the search for differentiated portfolio exposures uncorrelated with conventional equity or bond returns looms as a particular challenge.

In the defensive space, inflation-linked bonds or absolute return or  ‘unconstrained’ bond funds are worth consideration. Gold may also be a candidate but its traditional role as an inflation hedge is undermined somewhat by rising bond yields increasing the opportunity cost of holding gold.

If the RBA lags the Fed, which seems likely, then the Australian dollar (AUD) is likely to come under some pressure which may ameliorate any negative performance of unhedged global exposures.

One thing is clear, even if the RBA remains a ‘caged dove’, emerging inflation may cast the Fed as a ‘reluctant hawk’, heralding a requirement for investors to think more imaginatively about portfolio diversification.

 

Stephen Miller is an Investment Strategist with GSFM, a sponsor of Firstlinks. He has previously worked in The Treasury and in the office of the then Treasurer, Paul Keating, from 1983-88. The views expressed are his own and do not consider the circumstances of any investor.

For more papers and articles from GSFM and partners, click here.

 

RELATED ARTICLES

A tale of the inflation genie, the Fed and the RBA

It's not all about interest rates: give me a 1980s petshop galah!

Yikes! Three critical factors acting on inflation and rates

banner

Most viewed in recent weeks

Which generation had it toughest?

Each generation believes its economic challenges were uniquely tough - but what does the data say? A closer look reveals a more nuanced, complex story behind the generational hardship debate. 

Maybe it’s time to consider taxing the family home

Australia could unlock smarter investment and greater equity by reforming housing tax concessions. Rethinking exemptions on the family home could benefit most Australians, especially renters and owners of modest homes.

The best way to get rich and retire early

This goes through the different options including shares, property and business ownership and declares a winner, as well as outlining the mindset needed to earn enough to never have to work again.

A perfect storm for housing affordability in Australia

Everyone has a theory as to why housing in Australia is so expensive. There are a lot of different factors at play, from skewed migration patterns to banking trends and housing's status as a national obsession.

Supercharging the ‘4% rule’ to ensure a richer retirement

The creator of the 4% rule for retirement withdrawals, Bill Bengen, has written a new book outlining fresh strategies to outlive your money, including holding fewer stocks in early retirement before increasing allocations.

Simple maths says the AI investment boom ends badly

This AI cycle feels less like a revolution and more like a rerun. Just like fibre in 2000, shale in 2014, and cannabis in 2019, the technology or product is real but the capital cycle will be brutal. Investors beware.

Latest Updates

Weekly Editorial

Welcome to Firstlinks Edition 628

Australian investors have been pouring money into US stocks this year, just as they start to underperform the rest of the world. Is this a sign of things to come? This looks at 50 years of data to see what happens next.

  • 11 September 2025
Exchange traded products

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Retirement

We need a better scheme to help superannuation victims

The Compensation Scheme of Last Resort fails families hit by First Guardian and Shield losses, as well as advisers who are being wrongly blamed for the saga. It’s time for a fair, faster, universal super levy solution.

Investment strategies

5 charts every retiree must see…

Retirement can be daunting for Australians facing financial uncertainty. Understand your goals, longevity challenges, inflation impacts, market risks, and components of retirement income with these crucial charts.

Economy

How bread vs rice moulded history

Does a country's staple crop decide elements of its destiny? The second order effects of being a wheat or rice growing country could explain big differences in culture, societal norms and economic development.

Investment strategies

Small caps are catching fire - for good reason

Small caps just crashed the party like John McClane did in the movie, Die Hard - August delivered explosive gains. With valuations at historic lows, long-term investors could be set for a sequel worth watching.

Defensive growth for an age of deglobalisation, debt and disorder

Today’s new world order appears likely to lead to a lower return, higher risk investment environment. But this asset class looks especially well placed to survive, thrive, and deliver attractive returns to investors.

Economy

Will we choose a four-day working week?

The allure of a four-day week reflects a yearning for more balance in our lives. Yet the reliability of studies touting a lift in productivity is questionable and society may not be ready for such a shift anyway.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.