Following two consecutive months of hotter-than-expected Australian consumer price index (CPI) prints, it was a surprise to many that June inflation eased (see chart 1).
The headline June inflation came in at 4.1 per cent year-on-year (y/y), down from 4.4 per cent in May. Meanwhile, the Reserve Bank of Australia’s (RBA) second-quarter (Q2) trimmed-mean inflation figure was down to 3.9 per cent y/y, lower than both the first quarter’s 4 per cent and the consensus (4 per cent).
While inflation remains well above the RBA’s target range of 2–3 per cent, signs of deceleration encouraged investors. Following release of the June and Q2 inflation data, market expectations of the RBA’s rate path took a 180-degree turn: from rate hikes to potential cuts by late 2024.
But these expectations were short-lived. The RBA monetary policy meeting on August 6 dashed investor hopes by maintaining rates at their 12-year peak and stating that it expected inflation to take longer to return to target compared to prior forecasts (see chart 2).
The bank cited a strong demand outlook, elevated wage growth and the still-tight labour market as the main drivers behind its conclusion. At the media conference after the meeting, Governor Michele Bullock mentioned that there would be no cut on the agenda for the next six months and that the RBA will remain open to further tightening due to the upside risks of inflation.
As a consequence, future rate path expectations in Australia have changed yet again. As shown in the below chart, the overall curve of future interest rates priced in by investors has shifted up notably (see chart 3).
What does this mean for Australian portfolios?
The World Gold Council (WGC) believes these events have two main implications. First, in the near term, when upside risks of inflation remain elevated, the correlation between bonds and equities is likely to stay high. Such a pattern has been occurring between 2022 – when the RBA started hiking – and now (see chart 4).
Second, government bonds may become volatile depending on the course of inflation and on how much the central bank’s sentiment shifts – similar to the pattern we have seen recently. While local bond volatility has already been pushed to a multi-year high, the aforementioned uncertainties may keep it elevated.
This will likely have implications for Australian portfolios. Recent rapid changes in yields, amid notable shifts in rate expectations and the turbulence in equities, have led to a volatility surge in a traditional 60/40 portfolio (see chart 5).
Gold as a strategic component in Australian portfolios
In the face of rising volatilities, the WGC believes gold can provide diversification benefits for Australian portfolios. Unlike bonds, gold has demonstrated a consistently low correlation with Australian equities (see chart 6). This is mainly because gold’s valuation is not determined by any one country thanks to its diverse sources of demand – which spreads across regions and sectors – and supply.
Contrary to the perception that “gold generates no returns”, gold has, in fact, been the top performer among major global and Australian assets so far in 2024 (Chart 7).
Strong global central bank buying, robust Asian investment demand and elevated geopolitical risks combined to support gold’s performance in the first half (H1) of 2024. And it is worth noting that gold has generated positive returns every year since 2016, averaging 10 per cent per year in Australian dollars.
Looking ahead to the second half of 2024, gold is likely to draw further support as other major central banks continue their easing policies. Already, western ETF inflows have strengthened in response. And the factors that supported gold in H1 are highly likely to continue into H2, further enhancing gold’s allure, as the WGC explains in its mid-year gold market outlook.
As global financial markets witness increased volatility, geopolitical risks show no signs of abating and, in Australia, as uncertainty remains about the future path of interest rates, Australian investors face challenges in their quest to effectively manage their portfolios.
Gold offers a low correlation with local equities and attractive return prospects while acting as an effective hedge against geopolitical risks. As such, gold is an ideal asset to enhance return and reduce risk in Australian portfolios.
This feature was developed in partnership with World Gold Council.