Why Australia and the United States are recession-proof…for now
- Comparison of 90-day bills and 10-year government bonds indicates that the United States is recession-proof for now
- Australia has fewer recessions than the US due to a key policy difference
- Australian value stocks are better positioned than the US to weather any economic downturn
Brokerage and financial services firm Morgans is confident that the United States and Australia will avoid a recession as stocks recover from recent downturns.
Morgans chief economist Michael Knox said the US Federal Economic Database, or FRED, yield curve is a strong indication of whether the country is headed for a recession and, for at the moment, she seems positive.
He said it’s worth investors looking for themselves the 10-year Treasury constant maturity minus the 3-month Treasury constant maturity, which will bring up the chart below, which is a period 5-year bonds showing the difference between 90-day treasury bills and 10-year US treasury bills. obligations.
Selecting max at the top of the screen brings up over 40 years of data showing the difference between 90-day US Treasuries and 10-year US bonds.
“When you look at this chart, you’ll see that the Federal Reserve has already shadowed recessionary periods in the US economy for the past 40 years,” Knox said. Stockhead.
He said it is not the US Treasury but rather the National Bureau of Economic Research that determines when the US is in a recession and provides those recession dates.
It should be remembered that technically, a recession is defined as two consecutive quarters of negative GDP. On the graphs below, they appear as shaded gray areas.
Link between 90-day bill key and 10-year bonds
Knox said the problem is that the public debate has focused on two-year bonds and 10-year bonds.
“Whereas the overwhelming amount of federal research shows that the real link is between 90-day bills and 10-year bonds and currently they are still significantly lower,” he said.
This is where the inverted yield curve comes in, which can indicate a recession.
Knox said that after the Federal Reserve observed a few years of increased real demand for capital stimulating investment in the U.S. economy and driving up long-term interest rates, it will likely conclude, based on from rapidly rising wages and/or inflation, that the economy lacks the space to grow.
The Fed will then raise short-term interest rates relative to 10-year bond yields, and over time you will come to a point where 90-day US Treasuries will be higher.
Knox said when this happens, the yield curve inverts and the difference between the two drops to the line below zero.
“This is when the Federal Reserve has tightened to the point where it has choked off the flow of funds to new investment in the US economy and is likely to enter a recession after a while,” did he declare.
He said the latest chart indicates the yield curve is not inverted, suggesting the US is therefore not about to fall into recession.
Why Australia is different from the United States
Knox said the Australian and US economies also cannot be compared due to fundamental differences. Historically, Australia actually experiences fewer recessions than the United States.
“When the U.S. economy reaches full employment as it is now, below 4%, the only solution is to slow the rate of growth of the economy by raising Federal Reserve interest rates up to that it slows down and therefore may fall into recession,” he said. said.
“But in Australia we have a bipartisan skilled migration policy that the US doesn’t have so when we run out of people to give jobs we just speed up the rate of skilled migration and that keeps the economy going. .
“We don’t have to raise interest rates to the point of dragging the economy drastically into recession because we can find more people coming to Australia for jobs.”
Protection of Australian stocks
Knox thinks Australian stocks currently present better value than the US market, which is dominated by growth and technology stocks.
“The Australian market, especially the big companies, are value stocks,” he said.
Knox explains the escalating sell-off in US stock markets by the rise in 10-year bond yields.
“In 2020, 10-year bonds hit the lowest yields of 50 basis points since Alexander Hamilton first created the US Treasury bill in July 1789,” he said.
Knox said that at the start of the Covid-19 pandemic in 2020, US bonds were overbought because the US Federal Reserve was buying them as part of its quantitative easing monetary policy as the economy faced setbacks. a slowdown.
“Now that the Federal Reserve has stopped buying US bonds and started selling them, they’re coming back to fair value,” he said.
“It’s really this dramatic rise in US 10-year bonds that’s driving the sell-off in US equities.”
Knox said bonds are now falling in value and rising in yield, but that will impact equities for some time.
“What’s happening is that US 10-year bonds are reverting to fair value, which should be just below 3.5%,” he said.