Investors bail across the globe as US recession gauge flashes red

It’s the “recession barometer” that was accurate in the US five of the past six times. And it has just flashed red for the first time since the GFC, prompting a $20 billion sell-off on the Aussie share market.

Trader Peter Tuchman works on the floor of the New York Stock Exchange.

MORE than $20 billion has been wiped from Australia’s share market after one of the most reliable barometers of a recession in the US was tripped.

Nervous investors stripped 1.1 per cent from the key ASX 200 index today after fresh fears of a global economic slowdown rattled markets in the US and Europe overnight Friday.

In the second biggest fall for the Australian bourse so far this year, $20.4 billion was erased from the value of the nation’s biggest listed companies, with the technology, finance and energy sectors hardest hit.

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The slump is part of a global sell off, led by Wall Street, that was triggered by weak manufacturing numbers from key economies such as Germany and Japan, and by the yield curve on US government bonds inverting for the first time since 2007.

In the market for bonds — effectively IOUs issued by governments and companies who borrow funds from investors — an inverted yield curve is highly unusual.

It refers to a situation when the interest rate paid on long-term bonds falls below that paid on short-term government debt.

Traders work on the floor of the New York Stock Exchange as investors show growing concern about a slowing global economy.

Overnight Friday, the rate of interest paid on 10-year US bonds fell below that paid on three-month notes for the first time since before the global financial crisis last decade.

InvestSmart chief market strategist Evan Lucas said an inverted US yield curve had foreshadowed five of the past six recessions to hit the world’s biggest economy.

“It has certainly made people sit up and take notice,” Mr Lucas told Business Daily.

“Markets are risk off — investors expect interest rate cuts and an economic slowdown.”

Investors have dumped riskier shares to buy less-risky bonds — pushing the price up and yield down — as expectations around future economic growth and corporate earnings are lowered.

In Australia today, the yield on the federal government’s 10-year bonds hit a record low of 1.76 per cent.

That slide comes as investors become convinced the Reserve Bank will be forced to cut the cash rate to a new all-time low to prop up the economy.

The latest manufacturing numbers from economic heavyweights such as Germany, Japan and the US have failed to impress.

The previous low came in August 2016, when the RBA cut the cash rate to 1.5 per cent.

“People are piling into fixed income,” Mr Lucas said.

The Dow Jones Industrial Average lost 1.8 per cent and S&P 500 shed 1.9 per cent overnight Friday while equity markets in the UK, France and Germany all went backwards.

Factory output in the eurozone and Japan fell at the fastest pace in six and three years respectively, latest figures show.

US manufacturing activity has slumped to its lowest level in almost two years.

AMP Capital chief economist Shane Oliver said that while an inverted yield curve was a warning, a recession typically formed 15 months after long and short-term yields crossed.

The measure had given false warnings in the past, he said.

“To my way of thinking, its flashing amber,” Dr Oliver said.

“It’s warning there are potential risks to the US economy, including a recession, but it’s not bulletproof.

“If you look at other economic signs in the US, there is not much evidence of a recession.”

Oil and gas producers were particularly hard hit by Monday’s sell off on the Australian share market.

Dr Oliver said the US stock market had rallied 21 per cent since its December low, meaning it had been due for a pullback.

Low interest rates since the global financial crisis have helped produced the longest bull market in Wall Street history, with the S&P 500 up more than 300 per cent over the past decade.

Morgan Stanley chief investment officer Michael Wilson said further rate cuts would fail to excite investors given stocks in the US were already fully valued given the earnings outlook there. 

“Lower rates are only good to a point because eventually the fall in rates is not just about the Fed (US Federal Reserve) giving equity investors a “green light” to risk up, but it’s also about slowing growth,” Mr Wilson said in a research report.

“With the Fed now “all in” and stocks already fully valued, we think betting on another “look through” quarter is a bad risk reward.”