Recent market events have changed the direction of the Reserve Bank of Australia’s (RBA) opinion on the direction of interest rates. Many analysts and economists look at the yield curve to provide guidance when forecasting the future direction of the economy.
Where are we in the cycle and what is the warning in the Australian yield curve?
While most investors take their cue from Wall Street on the direction of the market, there is a growing belief that the yield curves of countries and continents such as the United States, United Kingdom and Europe, are no longer “honest” due to the enormous intervention by central banks into the bond markets. The change in yield on the bond market creates the so-called “yield curve”. When the curve moves down, it means an expectation of an interest rate cut as a result of the weakening economic outlook or recession.
Why does an expected change in interest rates predict a recession?
This is the case as interest rates tend to move the economy and central banks utilise interest rates to slow down or reinvigorate economic activity.
The Australian yield curve is one of the few remaining “un-manipulated” curves. We believe it may be more reliable in forecasting the economic outlook. Currently, the yield curve is pointing downwards for the next two years before rising again. This indicates that investors are expecting a recession sometime over the next two years. Further, we feel that if other nations had not manipulated their yield curve, they would also point downwards. Consequently, could the warning in the yield curve be right?
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