- The shape of the US yield curve has been an excellent predictor of US recessions in the past.
- ANZ has looked at whether the same relationship exists in Australia.
- It found that while Australia’s yield curve has been a fairly lousy predictor of recessions, it does convey information about whether economic growth will accelerate or decelerate in the period ahead.
There’s been a lot of market chatter about the US yield curve this year, specifically the narrowing differential between longer-dated and shorter-dated yields.
This “flattening” of the curve has led to speculation that two-year yields could soon lift above 10-year yields as the US Federal Reserve continues to lift rates, an ominous sign given a negative yield curve has almost always signalled that a US recession will follow soon after.
This chart from ANZ Bank shows the relationship between the shape of the US yield curve and US GDP growth on an annualised basis.
To be sure, the differential between 10 and two-year US bond yields is still positive at around 30 basis points, and there’s still some uncertainty as to how much quantitative easing from the ECB and BoJ is acting to suppress longer-dated yields, but the curve is currently the flattest that it’s been since 2007.
We all know what happened next.
Time and again, a negative yield curve has signalled that a recession in the United States is coming, usually within two years, sometimes sooner.
But does the same relationship between the shape of the Australian yield curve and recessions also hold true?
This next chart from ANZ is telling.
It shows the differential between 10 and three-year Australian government bond yields and GDP growth on an annualised basis going back to Australia’s last technical recession in the early 1990s.
“The track record of the US yield curve in signalling US recessions begs the question of whether the Australian Commonwealth Government Bond (ACGB) curve provides a similar signal about Australia’s GDP growth. The short answer is no,” says David Plank, Head of Australian Economics at ANZ.
“The ACGB slope has inverted on three occasions since 1994 and on none of these occasions has the economy slipped into recession.”
So why is the signal generated by the shape of Australia’s yield curve not anywhere near as successful as predicting Australian recessions?
Plank says there’s a simple explanation.
“The long-end of the Australian Commonwealth Government Bond (ACGB) curve is driven as much by the level of the 10-year US treasuries as it is by domestic considerations,” he says.
“Thus, the slope of the ACGB curve is a much less meaningful indicator of the domestic outlook than the US curve is for the US outlook.”
So whereas US 10-year yields are driven by expectations for the US economy, Australia 10-year yields largely reflect movements in similarly-dated US bond yields.
However, while the shape of Australia’s yield curve is not that great for predicting recessions, Plank says it does provide enough information as to whether growth will likely accelerate or decelerate in the period ahead.
“That is not to say there is no information content in the ACGB curve,” he says.
“The inversion in the late 1980s provided a strong signal about the coming recession. And the later curve inversions were followed by slowdowns in GDP growth; though to varying lags, extent and duration.”
At present, Plank says the slope for the ACGB curve is very close to the average level seen since 1990, meaning it’s not a major factor in determining ANZ’s assessment on the outlook for Australian economic growth.