Should the risk-free rate affect your allocation to equities?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
guanonics
Posts: 99
Joined: Thu Feb 10, 2022 10:47 am

Should the risk-free rate affect your allocation to equities?

Post by guanonics »

This is a theory question that has been bugging me and I'd love to get this community's take on it. The bogleheads wiki indicates that risk tolerance is the primary factor in determining equity allocation, stating:
How much in bonds? That's the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take risk. The more risk you can handle, the less bonds you need.
I'm wondering whether the risk-free rate plays any role in determining your equity allocation, especially relevant as the 30y TIPS yield has recently swung from negative territory to exceeding 1.5%. If real yields went to say 3% on the 30y TIPS, my lizard brain would feel tempted to buy some in lieu of equities.

Here's a few thoughts I've had:
  1. There is always a substantial equity risk premium, so I should ignore the risk-free rate. If the risk free rate is very high, the expected return of equities will be higher still. Making any changes in response, including reducing equity allocation, is market timing.
  2. A higher risk free rate reduces my need to take risk, so I should decrease my equity allocation.
  3. If the risk-free rate approached or exceeded the long term historical return for equities, I should dramatically reduce my equity allocation, because the equity risk premium is too low.
  4. With a historically high long term risk free rate, I should extend the average duration of my bond holdings to lock it in, but leave my equity allocation unchanged.
Does anyone here consider the risk-free rate in their IPS?
toddthebod
Posts: 5737
Joined: Wed May 18, 2022 12:42 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by toddthebod »

guanonics wrote: Wed Mar 29, 2023 11:50 am This is a theory question that has been bugging me and I'd love to get this community's take on it. The bogleheads wiki indicates that risk tolerance is the primary factor in determining equity allocation, stating:
How much in bonds? That's the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take risk. The more risk you can handle, the less bonds you need.
I'm wondering whether the risk-free rate plays any role in determining your equity allocation, especially relevant as the 30y TIPS yield has recently swung from negative territory to exceeding 1.5%. If real yields went to say 3% on the 30y TIPS, my lizard brain would feel tempted to buy some in lieu of equities.

Here's a few thoughts I've had:
  1. There is always a substantial equity risk premium, so I should ignore the risk-free rate. If the risk free rate is very high, the expected return of equities will be higher still. Making any changes in response, including reducing equity allocation, is market timing.
  2. A higher risk free rate reduces my need to take risk, so I should decrease my equity allocation.
  3. If the risk-free rate approached or exceeded the long term historical return for equities, I should dramatically reduce my equity allocation, because the equity risk premium is too low.
  4. With a historically high long term risk free rate, I should extend the average duration of my bond holdings to lock it in, but leave my equity allocation unchanged.
Does anyone here consider the risk-free rate in their IPS?
I do not take it into account, but I agree completely. I cannot be convinced that your ratio of equities to bonds should be the same whether bonds are paying 0.5% or 5% or even 15%!
User avatar
Vulcan
Posts: 2996
Joined: Sat Apr 05, 2014 11:43 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Vulcan »

Unless you invest in TIPS, the risk-free rate is only risk-free if you ignore inflation risk.
It is also only high if you ignore the inflation already present.
There is only one investment class I know of that stands the chance of beating inflation long-term.
If you torture the data long enough, it will confess to anything. ~Ronald Coase
km91
Posts: 1389
Joined: Wed Oct 13, 2021 12:32 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by km91 »

It probably should. If you set your AA by making some determination of the risk you are willing to take and the return you need to achieve to meet your financial goals, a higher risk free rate should mean you can take less risk with your total portfolio to meet your goals, all else equal. If you have a 5% real return target for your portfolio and 30yr TIPS go to 3%, you could take less equity risk and know you are still reasonably likely to meet the return target
User avatar
watchnerd
Posts: 13614
Joined: Sat Mar 03, 2007 10:18 am
Location: Gig Harbor, WA, USA

Re: Should the risk-free rate affect your allocation to equities?

Post by watchnerd »

If you believe in actively managing your AA, it probably should.

As the goal is to get a particular return vs risk, not hold a particular stock / bond mix for dogmatic reasons.

As for me -- no it doesn't, because the Global Market Portfolio chooses the stock mix of my risk portfolio for me.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
rockstar
Posts: 6326
Joined: Mon Feb 03, 2020 5:51 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by rockstar »

It impacts mine. Prior to rates going up I was nearly a 100% in equities. Now, that rates are higher, I’m around 70/30 as of today. I’ll probably shift closer to 80/20 as my bonds mature.

Now for bonds there are a bunch of questions:

High yield or investment grade or both?

What duration?

Bond fund or individual or both?

Domestic or International or both?

TIPS or Nominal or both?

Then you have allocation decisions based on the above.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Marseille07 »

guanonics wrote: Wed Mar 29, 2023 11:50 am This is a theory question that has been bugging me and I'd love to get this community's take on it. The bogleheads wiki indicates that risk tolerance is the primary factor in determining equity allocation, stating:
How much in bonds? That's the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take risk. The more risk you can handle, the less bonds you need.
I'm wondering whether the risk-free rate plays any role in determining your equity allocation, especially relevant as the 30y TIPS yield has recently swung from negative territory to exceeding 1.5%. If real yields went to say 3% on the 30y TIPS, my lizard brain would feel tempted to buy some in lieu of equities.

Here's a few thoughts I've had:
  1. There is always a substantial equity risk premium, so I should ignore the risk-free rate. If the risk free rate is very high, the expected return of equities will be higher still. Making any changes in response, including reducing equity allocation, is market timing.
  2. A higher risk free rate reduces my need to take risk, so I should decrease my equity allocation.
  3. If the risk-free rate approached or exceeded the long term historical return for equities, I should dramatically reduce my equity allocation, because the equity risk premium is too low.
  4. With a historically high long term risk free rate, I should extend the average duration of my bond holdings to lock it in, but leave my equity allocation unchanged.
Does anyone here consider the risk-free rate in their IPS?
Equity risk premium is fantasy.

That said, you still shouldn't worry about the risk-free rate because we reasonably expect equities to return higher than the risk-free rate. They might not, but since we don't know, it's a moot point to ponder.
Call_Me_Op
Posts: 9881
Joined: Mon Sep 07, 2009 2:57 pm
Location: Milky Way

Re: Should the risk-free rate affect your allocation to equities?

Post by Call_Me_Op »

No, but risk free real rate should.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
Topic Author
guanonics
Posts: 99
Joined: Thu Feb 10, 2022 10:47 am

Re: Should the risk-free rate affect your allocation to equities?

Post by guanonics »

Vulcan wrote: Wed Mar 29, 2023 12:00 pm Unless you invest in TIPS, the risk-free rate is only risk-free if you ignore inflation risk.
It is also only high if you ignore the inflation already present.
There is only one investment class I know of that stands the chance of beating inflation long-term.
Yes, TIPS. Also, quite a few asset classes have beaten inflation over the long term. I believe the source of this plot is Jeremy Siegel, it has been posted elsewhere on this site:
Image
Topic Author
guanonics
Posts: 99
Joined: Thu Feb 10, 2022 10:47 am

Re: Should the risk-free rate affect your allocation to equities?

Post by guanonics »

Marseille07 wrote: Wed Mar 29, 2023 12:20 pm Equity risk premium is fantasy.

That said, you still shouldn't worry about the risk-free rate because we reasonably expect equities to return higher than the risk-free rate. They might not, but since we don't know, it's a moot point to ponder.
Isn't the equity risk premium defined to be the expectation that equities return higher than the risk-free rate? I may have misunderstood your point.
Topic Author
guanonics
Posts: 99
Joined: Thu Feb 10, 2022 10:47 am

Re: Should the risk-free rate affect your allocation to equities?

Post by guanonics »

For what it's worth, I'm in accumulation and my bond allocation is entirely in TBills and IBonds. In response to high real rates, I've started to substitute some of the TBill allocation with 5y TIPS. I've been hesitant to buy anything longer since equities fill that role in my portfolio, motivating this post.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Marseille07 »

guanonics wrote: Wed Mar 29, 2023 12:58 pm Isn't the equity risk premium defined to be the expectation that equities return higher than the risk-free rate? I may have misunderstood your point.
There is no such expectation. Just because the risk-free rate is 4.5% doesn't mean you can expect equities to return higher. In fact it is usually the opposite because people flock to receive the risk-free rate instead of holding equities.
User avatar
Vulcan
Posts: 2996
Joined: Sat Apr 05, 2014 11:43 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Vulcan »

guanonics wrote: Wed Mar 29, 2023 12:53 pm
Vulcan wrote: Wed Mar 29, 2023 12:00 pm Unless you invest in TIPS, the risk-free rate is only risk-free if you ignore inflation risk.
It is also only high if you ignore the inflation already present.
There is only one investment class I know of that stands the chance of beating inflation long-term.
Yes, TIPS. Also, quite a few asset classes have beaten inflation over the long term. I believe the source of this plot is Jeremy Siegel, it has been posted elsewhere on this site:
Image
As is easy to see from this graph, bonds and t-bills have experienced multidecade periods of negative real returns in the past century.

Hence their moniker as certificates of guaranteed confiscation.
If you torture the data long enough, it will confess to anything. ~Ronald Coase
xxd091
Posts: 495
Joined: Sun Aug 21, 2011 4:41 am
Location: UK

Re: Should the risk-free rate affect your allocation to equities?

Post by xxd091 »

I still think the simple rule is when young -100% equities
As the pot increases and you have more monies at risk then add bonds
That’s it
Personally as a 77 years old U.K. investor-23 years rtd I used a Bogle Rule of amount of bonds in your portfolio equals your age or age minus 10
Worked for me and made enough to retire with a 30/70 -equity/ bond portfolio which I still have
Conservative type!
Maybe helpful to you as a rough but successful (so far) guide
Times may have changed but “it’s different this time” is an apocryphal saying that all investors have to cope with-so far proven to be untrue-mean reversion unfailingly seems to occur-so far!
xxd091
User avatar
nisiprius
Advisory Board
Posts: 52216
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Should the risk-free rate affect your allocation to equities?

Post by nisiprius »

There's a framework that is often used as a model for thinking about these things. I actually am not sure there's a name for the whole shebang, but it is the combination of Markowitz "modern portfolio theory" (MPT), the CAPM (capital asset pricing model), and Tobin's Separation Theorem.* I'm name-dropping these for identification but I don't actually understand them. However, when they come together, you see diagrams like this:

Image

In this framework, yes. Assume that we have a portfolio of stocks, bonds, and the risk-free asset. Assume that our goal is to optimize risk-adjusted return--maximize the Sharpe ratio. All else being equal, if the only change that happens is that the risk-free rate increases, then the optimum allocation shifts toward more equities, and vice versa.

The reason why this happens is that if you assume you have a "risk budget," a certain amount of risk you are willing to take, and if 100% stocks is too much risk, you always have a choice as to how you can reduce that risk. Combinations of stocks and bonds get you to places on the curve. If you are at the yellow dot, and you have too much risk--you are too far right on the curve--and you want to move left, you have a choice of two ways to do it. You can add more bonds, or you can add the risk-free asset. Adding bonds moves you left and down on the curve, adding the risk-free asset moves you left and down on the straight line. When you are at the optimum point--the yellow dot--it is better to adjust your risk by adjusting your cash holdings than by changing the stock-bond allocation.

In other words, assuming you are trying to keep your risk at a desired level, when the risk-free rate increases, you should hold more stocks in your stock-bond portfolio, because you should be using more of the risk-free asset as well. You want to dilute your stock risk with a mixture bonds and cash, and when the risk-free rate increases, you should be using more cash and less bonds to make the dilution.

Three other points that should be made. The first is that inflation doesn't change the theory, it just changes the values you plug in. Just use real rates for everything instead of nominal rates.

The second, and this is one that I think people get conceptually wrong, is that the optimum does not change if the return of stocks, bonds, and the risk-free asset all change together by the same amount. That just slides the whole diagram, curve, straight line, and all, up and down together, and the tangent point--the optimum stock/bond allocation--doesn't change. It is often assumed that something changes if the risk-free rate or the return from bonds becomes negative, but it is not so. Even though it is making the best of a bad situation, the best allocation remains the same.

I don't want to try to explain the framework, except to say that 1) it is neither realistic nor crazy. And that 2) if you are going to take it literally as a way of finding an "optimum," then you have a choice of thinking. Either
  • it tells you what would have been the optimum over some particular past pariod of time, or
  • it requires you to have accurate future predictions of the return, volatility, and correlation between the assets in the future.
Either way, it is much less interesting in any practical sense than words like "optimization" suggest.

The third is that if you are a risk-seeker--and, of course, if you can borrow at the risk-free rate--nothing changes except that some signs turn negative. If you are at the yellow dot and you want more risk, it is better to move right along the straight line--meaning to use leverage on the stock-bond portfolio--than to increase stock allocation. I'm just pointing that out as math. In real life that might not be a good idea because of the cost of borrowing, and also because the curve, which is a hyperbola, straightens out so much that the difference between the tangent line and the hyperbola is something that happens with perfect mathematical data and probably is lost in the noise in real life. Actually even in the picture you don't see any visible air between the straight line and the curve as you move up and to the right of the yellow dot.

*Modern portfolio theory gets you the "efficient frontier" curve, CAPM gets you the Sharpe ratio as the measure of risk-adjusted return to be optimized, and Tobin's Separation Theorem gets you the "capital markets line," the straight line that you make tangent to the curve.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
firebirdparts
Posts: 4414
Joined: Thu Jun 13, 2019 4:21 pm
Location: Southern Appalachia

Re: Should the risk-free rate affect your allocation to equities?

Post by firebirdparts »

Vulcan wrote: Wed Mar 29, 2023 9:05 pm As is easy to see from this graph, bonds and t-bills have experienced multidecade periods of negative real returns in the past century.
Unfortunately those bills seem to be forming a nice consistent weather pattern in the immediate past.

I suppose, though, that does make some sense, as the US was gold standard and then became the world's reserve currency during that. That's just telling us that, maybe.
This time is the same
User avatar
nisiprius
Advisory Board
Posts: 52216
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Should the risk-free rate affect your allocation to equities?

Post by nisiprius »

firebirdparts wrote: Thu Mar 30, 2023 9:05 am...I suppose, though, that does make some sense, as the US was gold standard and then became the world's reserve currency during that.
The US isn't "the" reserve currency, there are nine. It is indeed the most widely held, but it isn't unique. I don't think you would have the US being "the" reserve currency one day not being an official reserve currency the next, I think you would just see a gradual change in proportions between it and the others.

Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Caduceus
Posts: 3527
Joined: Mon Sep 17, 2012 1:47 am

Re: Should the risk-free rate affect your allocation to equities?

Post by Caduceus »

It will affect it in the sense that you're always choosing between competing investment alternatives. If the risk-free rate on some security is 2% ... that's buying something at 50 times earnings that can never grow and I wouldn't touch it because it should be quite easy to find equities (or baskets of equities) that will easily yield more than that over a reasonably medium term.

I've never been in a position where bonds have been attractive enough relative to equities, so apart from periods where I'm researching what to buy (and I've put the cash temporarily in I think it's called SHV or short-duration treasuries... stuff like that), I've always been 100% or more in equities.
User avatar
Lee_WSP
Posts: 10401
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Should the risk-free rate affect your allocation to equities?

Post by Lee_WSP »

If real rates on long TIPS increase to the point where you're going to be happy with the return, that obviously reduces your need to take risk. Your ability won't change and I'd expect your willingness will be reduced as well.
muffins14
Posts: 5529
Joined: Wed Oct 26, 2016 4:14 am
Location: New York

Re: Should the risk-free rate affect your allocation to equities?

Post by muffins14 »

Does it happen automatically if you just rebalance like a "normal" person?

If interest rates rise, bond values drop. If bond values drop, I should buy more of them to rebalance if equities are the same or higher. Does that mean I'm shifting more assets from stocks -> bonds when the risk-free rate has risen? It seems like it.

What about the opposite? If interest rates drop, bond values rise. If equities are the same or lower, I should be selling bonds to buy stocks. Does that mean I'm shifting more assets from bonds -> stocks when the risk-free rate has fallen? It seems like it.
Crom laughs at your Four Winds
Topic Author
guanonics
Posts: 99
Joined: Thu Feb 10, 2022 10:47 am

Re: Should the risk-free rate affect your allocation to equities?

Post by guanonics »

nisiprius wrote: Thu Mar 30, 2023 7:30 am There's a framework that is often used as a model for thinking about these things. I actually am not sure there's a name for the whole shebang, but it is the combination of Markowitz "modern portfolio theory" (MPT), the CAPM (capital asset pricing model), and Tobin's Separation Theorem.* I'm name-dropping these for identification but I don't actually understand them. However, when they come together, you see diagrams like this:
Thank you for taking the time to write out this post. The framework at least provides some structure to thinking about the problem, even if some of its inputs are unknowable.
rgs92
Posts: 3436
Joined: Mon Mar 02, 2009 7:00 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by rgs92 »

At times when money market and CD returns were very high, like 1982, in retrospect those were the best-ever times to buy stocks.
So a contrarian approach could be be best.
And this makes sense, because the high risk-free rate (nominal or real) provides competition for stocks and depresses their value.

So the answer to the OPs question in the title of this thread may be the opposite of one's intuition.
Last edited by rgs92 on Thu Mar 30, 2023 12:16 pm, edited 1 time in total.
the_wiki
Posts: 2883
Joined: Thu Jul 28, 2022 11:14 am

Re: Should the risk-free rate affect your allocation to equities?

Post by the_wiki »

Assuming the answer is "yes". How do you time these allocation changes? Do you have any reason to believe you are good at market timing stock returns and interest rate changes?
User avatar
enad
Posts: 1581
Joined: Fri Aug 12, 2022 2:50 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by enad »

I have never paid attention to the rate of returns for bonds or equities or even cash when setting my AA, to do otherwise would be market timing
What Goes Up Must come down -- David Clayton-Thomas (1968), BST
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Marseille07 »

rgs92 wrote: Thu Mar 30, 2023 12:13 pm At times when money market and CD returns were very high, like 1982, in retrospect those were the best-ever times to buy stocks.
So a contrarian approach could be be best.
And this makes sense, because the high risk-free rate (nominal or real) provides competition for stocks and depresses their value.
That's my take as well, although the efficient frontier chart tries to claim otherwise. Their argument is that stocks return even higher when the risk-free rate is high.
User avatar
Ben Mathew
Posts: 2720
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle

Re: Should the risk-free rate affect your allocation to equities?

Post by Ben Mathew »

guanonics wrote: Wed Mar 29, 2023 11:50 am This is a theory question that has been bugging me and I'd love to get this community's take on it. The bogleheads wiki indicates that risk tolerance is the primary factor in determining equity allocation, stating:
How much in bonds? That's the basic question of asset allocation. Before you decide, you first need to balance your ability, willingness, and need to take risk. The more risk you can handle, the less bonds you need.
I'm wondering whether the risk-free rate plays any role in determining your equity allocation, especially relevant as the 30y TIPS yield has recently swung from negative territory to exceeding 1.5%. If real yields went to say 3% on the 30y TIPS, my lizard brain would feel tempted to buy some in lieu of equities.
Asset Allocation depends on the equity premium. It's the difference between the expected return of stocks and bonds that matter. If both go up or down the same amount, there is no change in the relative attractiveness of either asset class, so no compelling reason to change the allocation.

For example, the asset allocation derived in Merton (1969) depends on the equity premium, not on the expected returns of stocks and bonds separately.
guanonics wrote: Wed Mar 29, 2023 11:50 am Here's a few thoughts I've had:
  1. There is always a substantial equity risk premium, so I should ignore the risk-free rate. If the risk free rate is very high, the expected return of equities will be higher still. Making any changes in response, including reducing equity allocation, is market timing.
  2. A higher risk free rate reduces my need to take risk, so I should decrease my equity allocation.
  3. If the risk-free rate approached or exceeded the long term historical return for equities, I should dramatically reduce my equity allocation, because the equity risk premium is too low.
  4. With a historically high long term risk free rate, I should extend the average duration of my bond holdings to lock it in, but leave my equity allocation unchanged.
Does anyone here consider the risk-free rate in their IPS?
I would be uncomfortable with the assumption that the equity premium is constant (1), or that the expected return of stocks is constant (2 and 3). Financial markets are markets like any other, and prices (valuations) change in these markets just like the prices of potatoes and tomatoes change in the grocery store. There is no law of constant price. So I think it's more reasonable to try to estimate the expected return of stocks (say, from earnings yields) and the expected return of bonds (say, from TIPS yields) and calculate the equity premium from there. This process remains responsive to potential changes in the relative valuations of these two assets.

I don't think of this as market timing. This is just responding to the current prices prevailing in the market. If tomatoes get expensive compared to potatoes, you buy less tomatoes and more potatoes. I think of market timing as strategies that try to predict changes in asset valuations rather than strategies that simply recognize current valuations.
Last edited by Ben Mathew on Thu Mar 30, 2023 1:31 pm, edited 1 time in total.
Total Portfolio Allocation and Withdrawal (TPAW)
km91
Posts: 1389
Joined: Wed Oct 13, 2021 12:32 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by km91 »

nisiprius wrote: Thu Mar 30, 2023 7:30 am There's a framework that is often used as a model for thinking about these things. I actually am not sure there's a name for the whole shebang, but it is the combination of Markowitz "modern portfolio theory" (MPT), the CAPM (capital asset pricing model), and Tobin's Separation Theorem.* I'm name-dropping these for identification but I don't actually understand them. However, when they come together, you see diagrams like this:
Mean-variance optimalization is the framework. MPT, CAPM and Tobin are key insights of this framework that help inform our understanding of the trade off between risk and return when risky and risk free assets are combined in a portfolio
Topic Author
guanonics
Posts: 99
Joined: Thu Feb 10, 2022 10:47 am

Re: Should the risk-free rate affect your allocation to equities?

Post by guanonics »

From this discussion, I now understand the following:
  • If I'm trying to maximize my return for an acceptable amount of volatility, changes to the risk free rate do not change the optimum portfolio according to Mean-Variance Optimization (MVO) theory unless the return premium changes. The return premium not knowable.
  • If I'm trying to minimize volatility at an acceptable amount of return, it makes sense to increase my allocation to risk-free assets in response to an increased risk free rate, according to MVO.
The conclusion from MVO that low or even negative real rates must be accepted without changes is a bitter pill to swallow.
Walkure
Posts: 1023
Joined: Tue Apr 11, 2017 9:59 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Walkure »

nisiprius wrote: Thu Mar 30, 2023 9:18 am
firebirdparts wrote: Thu Mar 30, 2023 9:05 am...I suppose, though, that does make some sense, as the US was gold standard and then became the world's reserve currency during that.
The US isn't "the" reserve currency, there are nine. It is indeed the most widely held, but it isn't unique. I don't think you would have the US being "the" reserve currency one day not being an official reserve currency the next, I think you would just see a gradual change in proportions between it and the others.

Image
This is curious, because of a sort of reverse home country bias problem. This is a table showing the relative percentages of all foreign reserves held by all governments - but presumably that includes the United States, whose reserves are apparently split between something called the ESF (guessing it stands for "Exchange Stability Fund"???) and the Fed's SOMA open market facility.
In total, the US reports $245 billion in foreign reserves (in Euros, Yen, and gold) here: https://home.treasury.gov/data/us-inter ... n/03242023. At the same time, the Fed's balance sheet holds what, $8 trillion with a T in US-denominated assets, but they don't count as "foreign reserves" because of course they are our own domestic currency.
Also curious is that ~$11 billion of the reserve is in that shiny barbarous relic, but footnote 3 discloses that the gold is being valued at an official exchange rate of "$42.2222 per fine troy ounce." If instead Treasury reported it at the market rate of $1,979 per ounce, that would be worth $517.5 billion, or more than double our holdings of Euro and Yen.

So my two takeaways: (1) For the purposes of assessing the US dollar's strength as the preeminent reserve currency, we would need to look at the percentages of only ex-US foreign reserves. (2) Any analysis that only looks at fiat currency holdings while ignoring central bank gold is missing a large part of the equation.
Marseille07
Posts: 16054
Joined: Fri Nov 06, 2020 12:41 pm

Re: Should the risk-free rate affect your allocation to equities?

Post by Marseille07 »

guanonics wrote: Fri Mar 31, 2023 9:15 am The return premium not knowable.
Right. We don't know if such a thing even exists.

As another poster and I said, it is arguable higher risk-free rate is a headwind for equities because money flows into risk-free assets paying high yields risk-free. Some folks bought Ally NPCD at 4.75% recently for similar reasons.
Post Reply