The same thing that has everyone freaking out about a US recession has happened in Australia too

David Scutt
  • Talk of a potential US recession has increased in recent days.
  • Another part of the US yield curve has inverted, meaning longer-dated interest rates are now lower than shorter-dated interest rates.
  • When this part of the US curve has inverted in the past, a recession has almost always followed.
  • The same part of the Australian yield curve also inverted today.
  • Unlike in the US, an inversion of this part of the Australian curve has been a lousy recession indicator. However, it often signals that the RBA may be about to cut rates.

When bond markets speak, financial markets and investors tend to listen. And if they aren’t listening, they probably should be.

Right now, bond markets are warning about a potential US recession with yields on 10-year US government bonds now lower than yields for three-month US Treasury bills.

Not since 2007 has that been seen, occurring just before the Global Financial Crisis hit.

The inversion of this part of the US yield curve — where longer-dated yields are lower than shorter-dated equivalents — has also been seen frequently before US recessions in the past, sparking concern among investors that the next economic downturn may now be just around the corner.

The inversion of the US curve has also sparked interest in other government bond markets, including in Australia.

Here’s something that will also attract a lot of attention: Australian three-month bank bill yields are now also siting above 10-year Australian government bond yields.

Here, look. The Australian interest rate curve has also inverted.

Commonwealth Bank

The chart comes courtesy of the Commonwealth Bank’s rates strategy team, showing the spread between three-month yields, compared to 10-year government yields, for both the United States and Australia going back to 2006.

So does the inversion of this part of Australia’s yield curve mean we should be on alert for a potential recession in Australia?

Maybe, but as seen in the chart below, while it’s been 12 years since this part of the curve inverted in the United States, it’s occurred on six separate occasions in Australia since the GFC, including today.

For those keeping score, on all five prior occasions before today, the inversion of the Australian curve did not coincide with a recession. Indeed, rather than warning about a recession, the inversion of the Australian curve has actually been a far a better indicator for when the RBA is about to cut official interest rates.

While this time could be different, what the Australian curve is really telling us is that current monetary policy settings from the RBA — if maintained — are likely to lead to sluggish economic growth and weak inflationary pressures in the decade ahead.

Along with renewed concern about the outlook for the global economy, that helps explain why financial markets, and many economists, now see the RBA delivering a series of rate cuts in the period ahead in an attempt to boost the Australian economy.

NOW READ: Australian bond yields hit rock bottom

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