This indicator is predicting a 100% probability of a US recession in the next 6-24 months

The inversion of the 10-2 treasury yield curve has predicted 100% of US recessions since 1955 and its just flashed again. Are we moving towards financial Armageddon? Let’s have a look at what this means for the Australian economy and property prices.

The 10-2 treasury yield curve is simply the difference in yield between two-year and 10-year bonds. When the two-year bond yields are higher it implies that the market believes it is riskier to lend money in the short term than it is in the long term. Every time this has happened a US recession has occurred in the following six to 24 months.

I have to preface this with the fact that I have no idea if the market is reading this signal correctly or not – nobody does. Although if history is any indication, then it’s probably on the money. Recessions are a normal part of the economic cycle and happen quite regularly. Even without looking at the bond yield, it’s painfully obvious that the US is in a world of trouble with government debt spiraling out of control, inflation (officially) at an alarming 8.5%, and an economy that has produced less than it has consumed for decades. If the US does go into recession what does this mean for Australia?

The old saying used to be “When America sneezes the rest of the world catches a cold” and for many years the economic fortune of Australia was linked to America. However, the world order is constantly changing. In the 1960s Australia’s major trading partners were Europe and the United States. By the 1970s Japan became our largest trading partner which remained the case for 26 years. By 2007 it was replaced by China and has remained there ever since. The direction of our economy has steadily moved from west to east primarily because that’s where all the economic growth is. But also, because the process of industrialisation is enormously resource-intensive, we happen to have an abundance of the highest quality and cheapest iron ore in the world. Today a whopping 65.2% of our trade is with Asia (28% from China alone) compared to 11.6% from the Americas.

Our economy has largely been shielded from the economic downturns of the last 30 years by the rapid growth of Asian economies. Prior to the Covid-induced event of 2020, the last recession we had was “the recession we had to have” in the early 1990s. In contrast, America went through four recessions over the same period. While it’s important to keep an eye on indicators like the 10-2 treasury yield curve it’s equally important to keep things in context. While we are still politically and culturally aligned with America our economy has largely decoupled from it. Even working in the industry, we occasionally need to remind ourselves that the Australian property market post-1960 has been remarkably resilient through a range of global conflicts and economic downturns. And it has remained perhaps the single safest asset class to be invested in over the last 60 odd years.

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