Is the inverted yield curve a problem for property?

Is the inverted yield curve a problem for property?
October 3, 2019 Carolyn Mowbray

With so much talk about inversion of the yield curve and what it indicates, the bigger question for property investors and lenders, is – what effect will this have on property prices?

The inverted yield curve where the official cash rate yield (now at 1 per cent) is higher than the 10 year bond yield (now at 0.92 per cent) can often point to a recession because when investors pile into long-dated bonds it means they are becoming more risk-averse about the economy.

In recent weeks the US saw the yield on its 10 year bond fall below that of the 2 year bond yields, causing a widespread stock market sell-off on Wall Street.

Lenders across the globe are forking out astonishing amounts of money, knowing they will incur a guaranteed loss.

Around one third of all government issued bonds now trade with negative interest rates.

So far this year, more than 30 central banks have cut rates, many of them from already record lows. Most are tying to undercut their currencies, to make their economies more competitive in a futile race to the bottom.

The solution to the financial crisis in 2008 was to throw huge amounts of extra debt at the problem and now there are debt bubbles everywhere. In some countries, it is at a government level. China has debt around 300 per cent of GDP.

In other places, the debt is at a corporate level. American companies now are in hock to the tune of $US9.3 trillion, that is not a concern so long as earnings keep rising.

In yet other countries, the debt is at household level. Australian households are indebted at around 200 per cent of income. Most of it is attached to mortgages, leaving our banks exposed.

Until now, ultra-low interest rates have pushed asset prices higher. But with growth slowing, corporate earnings under pressure and wages stagnating across the globe, the pressure is building, creating a stampede to sub-zero interest rates.

Longer term negative rates will impact on the banking system as banks are forced to hold government securities, and this will dent profits.

According to AMP Capital chief economist Shane Oliver, Australia’s inverted yield curve, the gap between 10 year bond yields and 2 year bond yields, was not far off from inversion. But the gap between the 10 year bond yield and the cash rate, which is the part of the yield curve that has been traditionally focused on in Australia, has given numerous false readings – most noticeably in the mid-1980s, in 2000, 2005 to 2008 and around 2012, that were not associated with recession.

Dr Oliver said the problem was the influence of lower long term bond yields overseas on domestic yields.

UBS global head of rates strategy Matthew Johnson does not agree there will be an inversion in the 10 year and 2 year bond yields but agrees that even if there was, it would not give the best signal of a recession.

Ivan Colhoun, NAB’s global head of research, also thinks that any forecast of a recession would need to be based more on a yield inversion overseas rather than in Australia.

Citi expect this is good news for equities and multiples on stocks have risen for those with reliable earnings.

The prospect of an economic recession in Australia would certainly bode poorly for Australian property markets.

If however, a yield inversion is more indicative of further shaking of world equity markets, we may well see a flight of capital to markets that are perceived as safer, such as “bricks and mortar”, further stimulating property markets in Australia.