Why the inverted yield curve doesn't mean NZ is headed for recession

Kiwi investors have nothing to fear from an ominous sign the US is about to into recession, experts say.

Yields on 10-year US Treasury bonds this week went below those being offered on two-year bonds. Every time this has happened in the past 50 years, the world's biggest economy has inevitably gone into a recession.

"In a typical environment, you would expect greater compensation for having your money held over the longer-term - particularly with the risk of not getting your money back and to account for inflation," NZIER principal economist Christina Leung told The AM Show on Monday.

"When people are uncertain about the future, they flock to the safety of bonds in the long-term because they actually want their money to be held for longer. That's when prices for bonds increase and yields decrease - so that's when yields on long-term are lower than short-term."

Yields in the US inverted right before the global financial crisis in 2008, the burst of the dot-com bubble in the early 2000s, the brief early 1990s recession and two recessions in the early 1980s.  

The yield curve, and how it precedes a recession every time.
The yield curve, and how it precedes a recession every time. Photo credit: Reuters

"The US economy is slowing, there's no doubt about it," ASB senior economist Chris Tennent-Brown told The AM Show. "The inverted yield curve... is telling you that investors are thinking, 'I want to get my money locked away in a safe asset for the long-term.'"

Although New Zealand is to a large degree at the whims of the global economy, both Leung and Tennent-Brown say there's no need to panic in this part of the world.

"In New Zealand though, it actually has not been that good of an indicator for recession," said Leung. "It's not necessarily a case that a recession has followed."

"We don't have an inverted yield curve, and it hasn't been a good indicator of what's going to happen here," added Tennent-Brown. He added that recessions in the US on average take 14 months to manifest following the yield curve inversion.

"The way that the curve turns around - and what investors are anticipating - is that the central bank will cut interest rates. That's already happening in the United States, which is the lead-in to the next growth phase."

Chris Tennent-Brown of ASB.
Chris Tennent-Brown of ASB. Photo credit: The AM Show

Another reason investors shouldn't panic, particularly if they're in it for the long-term, is fluctuations like the Dow Jones has seen this week happen all the time. It dropped 800 points in a day earlier this week, prompting a smaller drop in the local NZSX.

In the past - unless we read the financial papers - we just didn't notice these changes. Now we all have apps and access to financial data at our fingertips. 

"That's information that if you're a long-term investor, you should be ignoring," said Tennent-Brown.

"If you've got 20 years to go until retirement, there will be plenty of things to freak you out, plenty of ups and downs. This is just one of them. The US market is about 6 percent off its peak - it did exactly the same thing in May and bounced back in June. This volatility is normal - it's just that we see it all the time now."

Leung says New Zealand eyes should be on the trade war between the US and China, not the yield curve.

"The main uncertainty is how the trade war between China and the US will play out. So how that affects activity here in New Zealand, is if global demand was to fall, that in term would mean decreased demand - especially for our exports and lower economic activity."

Business confidence important - Collins

National Party MP Judith Collins told The AM Show there's plenty the Government could do to shield New Zealand from any potential global recession.

"There are certain things that are happening in the world that we can't control... but we can change some settings in New Zealand... one of the things that we could do is to basically not take our employment relations back to the 1970s, [support] people in business - particularly small business - and give people a chance to actually get ahead. We've got an 80 percent drop in business confidence in New Zealand - that is something we need to have going up, not down."

Recent analysis, however, has found there is no correlation between business confidence survey results and economic performance.

"Business confidence from countries other than NZ is a better predictor of NZ GDP than NZ business confidence is," University of Auckland statistics professor Thomas Lumley wrote recently on the Statschat blog.

"If you want to know how the NZ economy is doing, it seems you'd be better off asking Chinese or Swedish or Canadian businesses than Kiwi businesses."

The analysis found business confidence tends to dive when Labour is in Government, regardless of how the economy performs.

GDP growth is currently around 2.7 percent - lower than four years ago, but comparable to the first few years of National's last term in power, once the global financial crisis was over.

Judith Collins and Willie Jackson.
Judith Collins and Willie Jackson. Photo credit: The AM Show

Collins, however, said 2.7 percent is "not enough for a small economy like ours". 

There have been calls from economists for the Government to boost spending to stimulate growth, especially with the cost of borrowing so low.

Labour MP Willie Jackson, appearing alongside Collins on The AM Show, said Finance Minister Grant Robertson was instead choosing to "be careful", and the fall in unemployment showed that was working