Government bond yields around the world have reached decade highs, driven by higher energy costs and potentially ongoing inflationary pressures stemming from the U.S.-Iran conflict and disruption to global oil supply routes.

Beyond the immediate conflict, there are structural reasons yields may stay elevated. Government balance sheets across many advanced economies are increasingly stretched, with debt-fuelled expenditure supporting ambitious policy reforms – from defence to energy transition.

Beyond determining government borrowing costs, yields play a central role within the financial system. As the risk-free rate of interest, they underpin the cost of capital across the economy, meaning the current move higher in yields has implications well beyond bonds, reshaping valuations across equities, credit and real assets. If government bond yields stay higher for longer across most of the world, the cost of capital will also rise inexorably.

Higher yields translate directly into higher discount rates, and that matters for every asset in a portfolio. Whether its equities, credit or property, valuations are derived by discounting future cash flows at the risk-free rate plus a premium for investment risk. When that base rate moves higher, asset prices adjust lower.

A higher cost of capital will likely prompt investors to revise their hurdle rates higher for all investment opportunities and may suggest a more cautious approach to investment risk in general.

This could reveal vulnerabilities across asset classes which have benefited from a secular decline in interest rates, and therefore the cost of capital, over the past several decades.

Infrastructure, private credit and private equity have benefited from the valuation effects of a relatively low cost of capital, but this is now set to change as higher hurdle rates and revaluations unveil which asset classes and investment strategies can continue to sustain and deliver compelling risk-adjusted returns, and which will struggle to do so going forward.

“When the risk-free rate rises, every asset is repriced.”

Higher bond yields increase discount rates across equities, credit and property—resetting valuations and raising hurdle rates for all investments.

Turning to domestic developments, this month's Commonwealth Budget brought significant tax reform and policy announcements alongside a compositional change in revenue and expenditure forecasts that led to modest improvements in the budget balance over the next decade.

Drilling into the tax policy changes, reforms to capital gains tax (CGT) and negative gearing may make property as an asset class less attractive to investors and dampen investment activity in the property market.

Some analysts forecast a consequent moderation in house prices across the country and frame the contractionary economic effects of the tax reforms as akin to that of one or two RBA rate hikes, foreshadowing the conclusion of an already well progressed RBA rate hike cycle.

As investors reassess their portfolios for tax efficiency under the new CGT regime, fixed income and other income generating assets such as high dividend domestic equities could be well placed to benefit from this shift in focus.

Ultimately, the budget forecasts depict Australia's fiscal conditions in a highly favourable light relative to our peers, and re-affirms that Australia's government debt remains very low by global standards.

For investors, this environment calls for a fundamental reassessment of portfolio construction – where return is coming from, what risks are being compensated, and whether allocations built in a low-rate world remain fit for purpose in a higher-rate one.