- Bond yields in major developed nations have tumbled this week.
- This week, US 10-year yields fell below 3-month yields for the second time this year. The US yield curve inverted. When this has happened in the past a US recession almost always follows soon after.
- The Australian 10-year bond yield fell below Australia’s cash rate earlier this week. So part of the Australian curve inverted too.
- ANZ has investigated whether this signals a recession in Australia is on the way. In short, it doesn’t.
Bond markets are providing a troubling picture on what lies ahead for the global economy.
10-year yields have tumbled this week, including in Australia, indicating investors are becoming increasingly pessimistic on the outlook for economic growth and inflation ahead.
In some major economies, long-bond yields have actually fallen below shorter-dated yields, or inverted.
That was seen in the US yield curve this week with the differential between 10-year treasury notes and three-month bills going negative, sparking a wave of risk aversion given its excellent track record for predicting looming US recession.
Put bluntly, on almost every occasion that this part of the US curve has inverted, a recession has soon followed.
The US is not the only major developed economy to see a part of its curve invert this week. Australia has too.
On Tuesday, the yield on benchmark Australian 10-year bonds slumped to 1.481%, the lowest level on record, leaving it below the RBA cash rate which currently sits at 1.5%.
Put simply, the Australian cash-10-year curve inverted.
While this part of the Australian curve has since returned to positive territory, courtesy of a modest selloff in 10-year bonds on Thursday, and is likely to get even wider next week when the RBA will likely cut Australia’s cash rate, is the brief inversion seen this week something that should concern investors?
Is it signalling a recession is coming to Australia too?
Maybe, but if the chart below from ANZ is anything to go by, now’s probably not the time to run out and buy the latest addition of Australia recession: 2019.
It shows the Australian cash-10-year yield curve, overlaid against annual GDP growth in Australia.
While this part of the Australian curve has inverted on several occasions since Australia’s last recession in the early 1990s, including on that occasion, since then there’s not been an economic downturn.
Nor has the curve been all that great in signalling what economic growth will do in the period ahead, as David Plank, head of Australian economics at ANZ points out.
“It inverted in the later part of 2011, just as growth accelerated markedly,” Plank said in a note released on Thursday. “Given this we don’t see the current inversion as a development that on its own points to a sharp slowing in growth.”
But what about Australia’s “per capita recession” in the second half of last year, seeing quarterly growth measured in output per person decline for two consecutive quarters? Did the 10-year-cash rate curve predict that form of recession?
In short, no, Plank says.
“There was no flattening of of the curve ahead of this ‘recession’, or growth slowdown if we think in headline GDP terms,” he said.
“In our view this confirms that there is no reliable signal about the Australian growth outlook from the yield curve.”
So the Australian bond curve is pretty rubbish in predicting what’s likely to happen in the economy.
According to Plank, while shorter-dated Australian bond yields are influenced by expectations for monetary policy, economic activity and inflation, longer-dated yields typically reflect changes in the US bond market.
“In our view, is that the direction of the long-end of the AUD yield curve is driven by the direction of US rates,” he said.
So while Australia could be facing a recession, don’t be putting the bank on such a scenario occurring if its based entirely upon the inversion of the Australian bond curve.
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