Growth remains resilient, earnings expectations are still being supported by the AI capital expenditure cycle, and global trade has held up better than feared. But this improving risk backdrop is being tested by higher long-end yields, firmer inflation and a policy environment that is becoming harder for investors to confidently price.
The most important macro development over the past month has been the renewed pressure on global long-end yields. US Treasuries remain the world’s primary safe asset, but markets are increasingly demanding compensation for fiscal uncertainty, persistent inflation risk and the possibility that the neutral policy rate is higher than assumed. This is not confined to the US. Long-end yields have moved higher across a range of developed markets, including Japan, France and Australia. However, the US remains the focal point because borrowing needs are large, fiscal discipline is limited and policy signals have become harder to interpret. Treasury Secretary Scott Bessent’s efforts to lean against higher yields through larger long-end buybacks and a so-called “Treasury twist” have sharpened the debate around yield-curve control. The initial market response suggests official action may limit volatility at the margin, but it is unlikely to sustainably suppress yields while inflation, deficits and heavy issuance remain unresolved.
Long-end yields have risen materially
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In Australia, the policy outlook has also become more complicated. The latest inflation data was too firm to dismiss as noise. Upside surprises in discretionary categories such as domestic holidays and restaurant meals suggest household demand remains more resilient than expected. This weakens the argument that below-trend growth alone will be sufficient to bring inflation sustainably back to target. In our view, the RBA is likely to hike once more in November before ultimately cutting rates later in the cycle, once tighter policy weighs more clearly on confidence and consumption.
This backdrop argues against a binary portfolio response. Higher term premia and sticky inflation still warrant caution, but the income available across defensive assets provides a more meaningful buffer than earlier in the cycle. Bonds don’t need a rapid easing cycle to justify a role in portfolios. They provide important carry, diversification and some protection if growth slows more visibly over time.
Meanwhile, equity markets remain supported by earnings, but leadership and valuation discipline will matter more as yields rise. In our view, the strongest opportunities are still linked to structural investment themes rather than broad cyclical recovery. AI-related spending continues to provide an earnings tailwind, while the next phase of capital expenditure across Asia, energy, electrification and infrastructure is helping broaden the opportunity set beyond the narrowest group of market leaders.
This is also evident in the general strength of earnings seasons across a range of markets, which has continued despite weak consumer sentiment and persistent inflation risk. The divergence is important. Earnings cycles, and increasingly GDP outcomes, are being driven less by broad household demand and more by the capital expenditure cycle and its downstream effects across technology, infrastructure, electrification and industrial supply chains. It also reflects a more K-shaped economy, particularly in the US, where higher-income households account for a disproportionate share of consumption and are benefiting more directly from strong asset prices. This wealth effect is helping insulate aggregate spending and corporate earnings, even as sentiment measures and lower-income consumption remain under pressure.
For that reason, we continue to prefer exposures where earnings upgrades are more visible and where structural capital spending is already underway. This supports a constructive view on offshore equities, particularly those parts of the market benefiting from technology investment and stronger nominal growth. By contrast, domestic equity exposure still faces a more challenging mix of sticky inflation, tighter policy and softer activity, even if selected resource-linked sectors remain well supported by structural tailwinds.
Currency positioning has also become more important. We have become more negative on the US dollar, reflecting a topping in US growth differentials and ongoing fiscal concerns. If US authorities increasingly lean on long-end yields, global capital flows could shift meaningfully. Lower real returns would make Treasuries less attractive, pressure the US dollar and support assets including gold and emerging markets.
As always, diversification remains critical. A less constructive US dollar view, elevated fiscal uncertainty and still-present geopolitical risks make portfolio hedges more valuable. Real assets, gold and duration act as stabilisers if higher yields, policy mistakes or renewed volatility challenge both equities and bonds at the same time.
What this means for portfolios
This month we have shifted toward a higher hedge ratio, particularly against the US dollar. A more constructive view on the Australian dollar also supports this move and provides a nuanced method of incrementally adding risk at the margin. This was implemented by switching part of our US equity bucket from unhedged to hedged, while continuing to build back our position in European equities via an unhedged exposure. We now sit with a mild overweight across the three major developed market regions, with a preference for Japanese equities and US tech within this section of portfolios.
At home, we took the opportunity to modestly reduce our underweight to Australian equities this month, primarily via an increase to our Materials overweight where we see better support given the AI build-out and the ongoing shift to a more multipolar environment.
To account for the moderate increase in risk, we have taken duration to neutral. Even with the market fully priced for a rate hike by November, we expect the RBA is close to the end of its hiking cycle. Subdued economic activity, ongoing deleveraging and fiscal constraints could favour longer-duration bonds. As a result, we have moved Australian long duration to a mild overweight funded by bank bills. The portfolio reflecting a flattening bias after the changes.
We also moved gold to a mild overweight given renewed central bank demand and its role as a portfolio hedge.