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.

 

  •   18 August 2021
  • 1
  •      
  •   

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

It’s time for LICs to die

A high-profile dividend cut and a prominent fund manager’s apology have reignited a long-running debate. If investors can access similar exposures more cheaply and efficiently elsewhere, what exactly is keeping LICs alive?

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

The new capital gains tax trap for your portfolio

Investors have long accepted one portfolio rule without much question. A major tax shift could change that calculation entirely, forcing difficult trade-offs between risk, discipline and an overlooked cost lurking beneath.

The retirement scorecard: how many of these questions can you answer?

From the maths of retirement, estimating spending and picking the right asset allocation to survive a poor decade, here are the questions every retiree – current or future – should be able to answer for themselves.

How the typical Australian Family could save $844,350 in taxes

The value of a testamentary trust is not determined by wealth alone. Depending on circumstances, it can reduce the tax burden on inherited income, create efficiencies and help build intergenerational wealth.

The housing slide could become a crash

House prices are sliding across Australia, yet the most dangerous ingredient for a housing crash is still missing. If job losses surge amid growing economic risks, today's correction could become a historic property downturn.

Latest Updates

Testamentary trusts: Treasury has picked the wrong reading

A decades-old estate planning tool has survived one tax crackdown only to be caught by another. The surprise isn't who the reform is targeting, but who could end up paying the price for drafting choices made years ago.

Latest from Morningstar

Does an American retirement rule work for Australians?

The 4% rule has survived decades of scrutiny, but Australia's retirement system changes the equation in ways most overlook. Before accepting or rejecting this rule of thumb, it pays to understand what really drives retirement outcomes.

Shares

Glencore lands on the ASX. Should BHP and Rio shareholders switch?

A coal-heavy miner with governance concerns isn't the obvious choice for investors. Yet, Glencore's ASX listing may offer something BHP and Rio can't. The challenge is working out whether the opportunity outweighs the risks.

Why does the system treat capital gains and losses differently?

Investors are often told not to let tax policy drive their investment decisions. Yet, under the new CGT rules, portfolio construction, volatility and even how assets are owned may have an outsized impact on their final outcome.

Economy

Three common sense reforms that Australia needs

What do frozen bank accounts, mortgage traps and pension penalties have in common? They're all symptoms of a system that makes life much harder. Yet the obvious solutions seem to have escaped the attention of Canberra.

Shares

The hidden cost of government debt for investors

Some of the important effects of rising public debt never make the headlines. Research shows the immediate effects may already be unfolding, influencing corporate behaviour in ways that many investors would never suspect.

Investment strategies

When do fundamentals matter?

Is fundamental investing losing its grip on markets? Investors continue to search for valuation-based explanations for every price move, but the dominant force behind short-term returns may be something else altogether.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 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.