• Comparison of 90-day bills and 10-year government bonds indicate US safe from recession for now
  • Australia has fewer recessions than US due to one key policy difference
  • Australian value equities better placed than US to ride out any economic downturn

Brokerage and financial services firm Morgans is confident the US and Australia will avoid a recession with stocks recovering from recent downturns.

Morgans chief economist Michael Knox said the yield curve on the US Federal Economic Database, or FRED, is a strong indication of whether the country is heading for a recession and at the moment it is looking positive.

He said it’s worth investors themselves looking up 10-year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity which will bring up the chart below, which is a 5-year period showing the difference between 90-day Treasury bills and US 10-year bonds.

By selecting max at the top of the screen more than 40 years of data comes up, showing the difference between US 90-day Treasury bills and US 10-year bonds.

“When you look at this chart you will see that the Federal Reserve has already shaded in the periods of recession in the US economy in the last 40 years,” Knox told Stockhead.

He said it is not the US Treasury but rather the National Bureau of Economic Research that determines when the US is in recession and provides those dates of recessions.

It is worth remembering technically a recession is defined as two consecutive quarters of negative GDP. On the below graphs they show up as the shaded grey areas.


Link between 90-day bill and 10-year bonds key

Knox said the problem is the public discussion has been about two-year bonds and 10-year bonds.

“Whereas the overwhelming amount of Federal research shows the real link is between 90-day bills and 10-year bonds and right now they are still significantly lower,” he said.

This is where the inverted yield curve comes in to play, which can indicate a recession.

Knox said after the Federal Reserve has observed a couple of years of increasing real demand for capital driving investment in the US economy and driving up long-term interest rates, it will likely conclude, based on rapidly rising wages and or inflation, that the economy is running out of room to grow.

The Fed will then move to push up short-term interest rates relative to where 10-year bond yields are and in time you will get to a point where US 90-day Treasury bills are higher.

Knox said when that happens, the yield curve inverts, and the difference between the two drops down to the line below zero.

“It is that point when the Federal Reserve has tightened to where it has choked off the flow of funds to new investment in the US economy and is likely to go into recession after a period,” he said.

He said the latest charting indicates the yield curve is not inverted, suggesting the US is therefore not about to fall into recession.

Why Australia is different to US

Knox said Australia and the US economies can’t also be compared because of fundamental differences. Historically, Australia actually has fewer recessions than the US.

“When the US economy gets to full employment as it is now, below 4%, the only solution is to slow down the growth rate of the economy by the Federal Reserve lifting interest rates until it slows and consequently can fall into recession,” he 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 to we just accelerate the rate of skilled migration and that keeps the economy going.

“We don’t have to put up interest rates to the point it slows the economy dramatically into recession because we can find more people to come to Australia to fill positions.”

Australian equities protection

Knox believes the Australian equities at the moment present better value than the US market, which is dominated by growth and tech stocks.

“The Australian market, particularly large corporations, are value stocks,” he said.

Knox puts down the escalation in equity market sell-offs in the US to the rising 10-year bond yield.

“In 2020 10-year bonds got to the lowest yields of 50 basis points since Alexander Hamilton first created the US Treasury bond in July 1789,” he said.

Knox said during early stages 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 a downturn.

“Now as the Federal Reserve has stopped buying US bonds and started selling them they are returning to fair value,” he said.

“It’s really that dramatic increase in US 10-year-bonds which is driving the very dramatic sell-off in US stocks.”

Knox said simply bonds are now going down in value and up in yield but this will have an impact for a while on equities.

“What is happening is US 10-year-bonds are returning to fair value, which should be just below 3.5%,” he said.