Bond market meltdown signals Australian recession risk is rising
Most economists still expect Australia to avoid a recession, but government debt costs are now at 15-year highs as bond traders price in a stormy economic outlook.
Surging Australian government bond yields signal that traders believe the economy is set to dramatically slow as an inflation rebound threatens a recession.
March’s bond market meltdown sparked by the Middle East conflict and soaring energy inflation is also raising the interest bill for the Federal Government’s near $1 trillion debt pile, ahead of its May budget.
On Friday, the yield on one-year Australian government debt rose to 4.67 per cent, its highest level since the end of the GFC in July 2011, when Australian benchmark interest rates equalled 4.75 per cent.
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By continuing you agree to our Terms and Privacy Policy.The yield on 10-year Australian government debt also hit a 15-year of 5.02 per cent on Friday, as fixed-income traders react to expectations inflation could reach between 4.5 per cent to 5 per cent later this year.
Economist, Warren Hogan, said he thinks there’s now a 50 per cent chance Australia enters a recession within the next two or three years, with the cash rate needing to go as high as 5 per cent to smother inflation, unless the government reins in spending.
“My view is that’s where the cash rate will end up if the governments of Australia don’t do some fiscal tightening and play a role in getting this inflation under control,” he said. “Whether that cash rate’s in six or 18 months’ time I don’t know, but the market is starting to play with that idea.
“And the bond (market’s) move over the past month is this idea that the RBA is risking getting behind the curve and wasn’t getting on top of inflation.”
Threat of a major economic downturn, UK debt sinks
Mr Hogan added that short-term Australian government debt rates had spiralled particularly quickly over the past week due to the Middle East war stoking inflation worries and warned the chance of a “major economic crisis” is up to 40 per cent over the next couple of years.
“My view is none of the underlying policy settings — monetary, fiscal, wages policy, and productivity initiatives are dealing with the realities we must face up to, which is a workforce in decline, so labour shortages, and an impressive, high-impact tech in AI,” he said.
“So big government spending is pressuring the rest of the economy and we’re putting the economy at risk of a major recession, worse than a garden variety,” he said.
Around the world, government bond yields have also surged since the Middle East war, as investors cancel bets on interest rate cuts from major central banks to factor in the hit from energy price inflation.
The yield on one-year US government debt is up 22 basis points in a month to 3.37 per cent.
However, much of the focus on Friday in Australian fixed-income markets was on the UK. Its government’s interest rate costs spiked again on Thursday after the Bank of England flagged a potential interest rate increase.
The yield on UK one-year government debt has now surged 97 basis points over the past month to 4.31 per cent to signal a ballooning panic over the health of its national balance sheet as soaring oil and gas prices wreak additional havoc.
Australia already slowing
Others strategists, including Damien Boey at Wilson Asset Management, believe Australia’s economy has slowed sharply since the start of the year as interest rate increases, a higher exchange rate, and higher bills eat into the purchasing power of consumers.
Mr Boey acknowledged that government debt costs have surged to 15-year highs, but suggested the extent of the existing slowdown means the local economy may be somewhere near peak pain at the moment before the central bank can move to lower rates over an unspecified timeframe.
“Our modelling already tells us the economy slowed sharply this year,” said Mr Boey. “The yield curve is flattening and people say is that a recession signal? Look, I don’t want to be too bearish (negative) and we expect a slowdown, but not a recession. And the RBA said there might be pain ahead, so people will have to take the good with the bad to bring inflation down.”
Yield curve inversion on watch
The narrowing 33 basis points gap between the Australian one-year yield of 4.67 per cent and 10-year bond yield of 5 per cent on Friday is putting traders on watch for a yield curve inversion, where short-dated debt yields top long-dated debt yields.
This inversion is a traditional signal that powerful bond investors expect an economic recession as high short-term borrowing rates kill demand and economic activity.
“Typically the pre-cursor for a recession is an inverted yield curve,” said Andrew Grant an Associate Finance Professor at the University of Sydney.
”Obviously it (the Australian yield curve) has to flatten like this phase now before it gets to that point and it’s not a perfect recession predictor, but it’s historically signalled that. And for now we don’t know if this is just a short-term inflation blip as people are unsure about oil prices, so I don’t think market pricing is telling us to expect a recession just yet.”
