MORE ON YIELD INVERSION
The following points came out of PIG’s April 2019 meeting.
Yield curves as shown in the Forum show rate inversions in USA and Australia. In
USA a rate inversion typically precedes a recession by 15 months but in Australia
the linkage is not as definitive. A look at bond mechanisms showed the following
Bonds yields (Govt in this example) are inversely related to bond value. If
bond yields fall, bond prices increase. Conversely, if bond yields rise then
bond prices fall.
USA and AUS monetary policy post GFC was to stimulate the economies
by increasing money supply and decreasing interest rates.
USA Federal Reserve did this by buying bonds in the open market. Bond
prices lifted, Govt funds were thereby injected into the economy
In AUS the RBA seems to prefer public announcements via the
management of the cash rate that influences the economy and perhaps
some money supply management.
In USA in early 2018 the FED commenced quantitative reduction with the
effect that interest rates rose and equity markets re-rated earnings
outlooks and re-priced many stocks. Two major equity market slumps
occurred in February and December. Investor opinion was that further
tightening would negatively impact on the markets.
AUS followed USA equity markets down.
In 2019 equity market pessimism declined despite many international
economic challenges so that USA and AUS equities have recovered much
of the downturn.
Investors now see some future downturn in economic conditions that will
require the FED and our RBA to reduce interest rates and ease credit. The
bond markets have therefore risen strongly given that investors held cash
and expect to benefit when the central banks reduce official rates.
The questions are now:
Will FED/RBA return to quantitative easing?
Does the yield inversion theory on recession not apply any longer?
Should our actions be to tough out market corrections or should we sell
shares and increase our cash (minimum yield at the moment) and wait to
buy low equities on market slumps?