The persistence of negative real interest rates across developed cash and government bond markets contradicts our conventional understanding of a risk-free rate. We must therefore abandon our assumption that a positive real risk-free rate of interest undergirds the long-term returns of our investment portfolios. Central banks have engineered these negative rates through large-scale purchases of securities from the market and the corresponding creation of bank reserves. If and when they take the next step of direct money creation, as is increasingly being discussed, long-run risk of inflation will rise. Investors should consider repositioning their portfolios now to avoid the zero to negative returns of cash and government bonds and to protect against long-term inflation. Investors should diversify away from government bonds and U.S. equities into higher-yielding inflation-sensitive asset classes such as commodities, bank loans, high-yield bonds, REITs, and emerging market equities.
Please visit our interactive Asset Allocation website.
Brightman, Chris. 2015. "What's Up? Quantitative Easing and Inflation," Research Affiliates Fundamentals, January.
Dudley, William C. 2016. Remarks at the Federal Reserve Bank of Atlanta 2016 Financial Markets Conference, Fernandina Beach, Florida, May 1.
Flanders, Stephanie. 2016. "The Hurdles to 'Helicopter Money' Are Shrinking." The Financial Times, May 11.
Reinhart, Carmen M. and Kenneth S. Rogoff. 2009. This Time Is Different, Princeton, NJ: Princeton University Press.
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