Australia’s Inverted Yield Curve – Update

Today, the RBA’s cash target and overnight rate is 3.50% compared to the yield on the Australian 10 year government bond of 3.33%.

The yield curve remains inverted. If the RBA cuts rates another 25 basis points to “un-invert” the curve, they risk a weakening of the AUD (which should be desired in order to make Australian exports competitive) as global capital will earn less on their carry trade and perhaps sending a signal that the economy actually needs a larger kick of stimulation that what was thought.

When I combine our observations in the credit markets, the analysis is suggesting (which is being confirmed with action seen Asian equity markets) that the short-term trends in the AUD and the ASX 200 are shifting into weakness.

It is worthy to note that the yield curve is close to being normal again.

At this stage, I view this short-term correction as an opportunity to accumulate selected Australian equities. I feel that the Aussie equities index (together with Shanghai) will see it’s low for 2012, a couple months earlier than the yearly lows that I anticipate to occur in the U.S. which surrounds the November period.

Listen to the market – China’s inverted yield

The spread between the yield of Chinese Govn’t 2yr and 10yr bonds have inverted. The yield that an investor is receiving buying 2 year maturing debt is higher than the yield from a 10 year bond.

Although the data on the attached graph only starts in 2005, an inverted yield curve signals stress in the credit market and leads to weaker equity markets. It is often a good indicator that precedes recession or a change in economic cycles.

It is notable that United States 2’s/10’s spread inverted in 1978, 1988, 2000 & 2006. Recessions followed within 12-18 months.

The trade to look at, is for a falling Australian Dollar. With this comes a rising US Dollar and falling commodity prices.

An inverted Chinese bond yield could spell trouble for the most crowded of “longs” because not many believe BHP, RIO and the Australian Dollar can fall – for China will apparently keep saving them all.

It is highly likely that China will still buy their products, but there is such a thing as cycles and although China has seemed to have avoided one in the past 15 years, the optimism in this post is to be ready to buy some bargains in Australia, China along with some commodities.

In the meantime, selling AUD and buying USD is hardly the worst trade to consider.

source - Bloomberg

Australia’s inverted yield curve makes America a fertile investing habitat

Today, Australia’s 10 year government bond yield fell below the Reserve Bank’s overnight cash rate for the 1st time since early 2009.

Historically, an inverted yield curve is correlated with moderating inflation, weakening economic activity and possibly suggesting signs of an economic downturn.

Could this precede the official call of a recession? I think the implications are still not fully accepted, meaning Australia remains in denial, for China will apparently save us.

Although I’m bullish on China and commodities, there are phenomenons called “cycles”. Prices do revert to their mean and the Australian Dollar can fall.

Global investors could do well to sell (high) their strong AUD, CHF, JPY or EUR and buy (low) the weaker, cheaper USD.

To enter the world of folly, this could be a turning point for the U.S. Dollar and its rise would have various implications on assets ranging from the Swiss Franc to commodity prices.

Forget the U.S. government’s woes. I prefer to treat the U.S. government and its bonds, if you will; similar to the equity or debt of any other U.S. company. I consider the equity and debt of McDonald’s Corporation is more creditworthy than that of the U.S. government.

Furthermore, investors with USD are searching for returns (as cash currently earns zero) and with a S&P 500 PE of 12 thus giving it an earnings yield of 8%, this is a nice “pick-up” of 5% over the U.S. government 10 year bond….

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