The Federal Reserve’s clear shift towards easing monetary policy has also given rise to further inversion of the US yield curve. The difference between the 10-year and 3-month interest rates has persistently flirted with zero since March this year, leaving many wondering if this could be a precursor to an impending recession.
Indeed, the Federal Reserve assesses the probability of a recession using this interest rate differential, publishing their findings on a monthly basis. As at 30 June, it was implying a 33 per cent chance of a recession in the US in the coming 12 months. This is eerily close to the 35 per cent chance the curve implied in the lead-up to the global financial crisis (GFC). So how worried should we be?
The US yield curve is certainly telling us something and, while ANZ Research is not expecting a US recession, forecasts are for Fed rate cuts over the rest of this year. Risks to the global economy are certainly heightened at present but ANZ Research thinks the markets’ expectations for US rate cuts are more about the weak inflation outlook than a widespread expectation a recession is imminent.
That said, plenty of people argued adding additional fiscal stimulus to an already hot US economy last year would end in tears in 2020. And yield curve inversion does tend to be quite agnostic about timing. So ANZ Research certainly are not ruling out the possibility the yield curve could have the last laugh.
Common in NZ
So what about the New Zealand experience? The local yield curve has spent time in inverted territory recently too. Should Kiwis be worried?
Firstly, New Zealand 10-year yields are highly correlated to global 10-year yields, meaning changes to the global economic picture can drive them as much as the local data does. Of course, changes to the New Zealand economic outlook (including inflation expectations and perceived risk, not just the growth outlook) also play a part in how the New Zealand 10-year yield trades.
Typically, in times of rising global uncertainty, NZ 10-year yields will move lower to reflect global headwinds. However, as a small open economy, these global headwinds impact New Zealand too, so a lower 10-year yield isn’t inappropriate.
What about the short-term part of the equation? The standard reference 3-month interest rate in New Zealand is set in the Bank Bill market. This market has in recent years become increasingly illiquid, with the 30-day rolling turnover averaging approximately $NZ100 million. This makes it more volatile.
This rate is also relatively less sensitive to changes to interest rate expectations (as opposed to the 3-month OIS rate for example) and has in some instances even lagged a cut to the OCR. It therefore isn’t going to be a perfect measure of near-term interest rate expectations.