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Yield inversion not necessarily omen of recession

Investors and advisers are being told not to read too much into an inverted bond yield curve.

Tuesday, April 23rd 2019, 5:00AM

In the US, long-dated bonds now have lower yield than short-dated bonds, which indicated the market is betting on an imminent recession.

New Zealand's yield curve is still largely flat.

Bevan Graham, AMP Capital New Zealand managing director, said speculation was rife that the inversion was a "harbinger of recessionary doom".

But he said, while every US recession had been preceded by flattening or inversion of the yield curve, it was not true that every inversion had led to a recession.

"There are a number of reasons why we don’t think it will this time. There is still the question of the extent to which the Fed’s quantitative easing programme has and still is suppressing yields by way of decimation of the term premium.

"Assuming that is the case and that longer-dated yields are artificially low, then it follows that the yield curve is artificially flat.

"At the same time, a number of other factors that tend to accompany the yield curve flattenings that have preceded recessions are not present. In particular, bank lending growth remains positive and credit spreads remain tight. We would start to become more worried about the state of the US economy should the inversions become deeper and more sustained, but also accompanied by other factors including lower lending growth and a widening of credit spreads."

MJW analysts said the New Zealand curve had inverted for a sustained period between 2004 and 2008.

"While yields are significantly lower today, the curve is not especially differently shaped from what it was in July 2004... The current situation, therefore, far from guarantees that a recession is around the corner. One should be cautious of
trying to time the market."

Graham said he was still cautiously positive on equities because economies around the world were in moderate expansion and there was no embedded inflationary trend.

"While there are risks that could push the markets periodically downwards, we believe last year’s volatility and downward market moves have restored some value, and that the ultimate trend will be towards higher international equity markets by year end."

He said AMP Capital had used the December and January uncertainty to lift its exposure to international equities.

"It is unlikely that such opportunities will recur in international equities near-term, but there may be scope for a better entry point for added exposure to Australian and even emerging market equities."

Tags: AMP Capital bonds MJW

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