Yield curve inversion, question of if Australia will be affected, but when

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Yield curve inversion, question of if Australia will be affected, but when.

A once-in-a-generation financial disaster is looming — and everyday Aussies will be caught up in the fiasco, an Australian economist has warned.

Former Coalition policy adviser John Adams made the grim prediction today after the US bond market experienced an inversion of the “one year to 10 year” yield curve.

Mr Adams said that inversion followed two or more quarters of negative economic growth — the most telling sign of an impending US recession.

And he told news.com.au it was not a question of if Australia would be affected — but rather when and to what extent.

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The yield curve is inverted when the yield or interest rate on short-term bonds is higher than that on long-term.

In other words, in this case it means the demand for short-term, one-year US government treasury bonds has dropped while demand for longer-term bonds has increased — which means it’s harder for institutions to lend profitably, which causes a credit squeeze.

According to Mr Adams, it’s usually a sign of overly restrictive policies occurring at the same time as economic growth slowing.

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He said it was the direct opposite of what usually happens in healthy economies, when bonds with longer maturity periods tend to pay investors higher interest rates.

Mr Adams said an inversion of the “one year to 10 year” yield curve had been the most accurate prediction of a coming recession since the 1960s — a phenomenon also recognised by the US Federal Reserve.

Since 1955, it has occurred in the lead-up to nine economic recessions and has only produced one false-positive reading in September 1965.

On Friday, it flipped again. A Treasury bill that matures in three months is yielding 2.46 per cent — 0.03 percentage points more than the yield on a Treasury that matures in 10 years.

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Mr Adams said that meant the official countdown to “economic Armageddon” had now begun, with a US recession, based on the historical experience, likely to commence in the next three to 27 months.

He said a recession in the US was likely to have global consequences as America still had the world’s biggest economy — and that the impact on Australia would depend on government decisions.

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