Investors are fixated on the inverted yield curve and growing risks of a recession that could send equity markets into a meltdown, but the yield inversion could perversely be also seen as a signal to snap up risk assets.
A yield curve inversion is when the yield on a long-term US government bond drops below a short-dated US government bond. This focus has largely been on the 10-year treasury yield vs. the two-year yield.
Whenever the yield inverts, it has been a relatively reliably indicator or a looming recession although Morgans believes there is a better signal to watch.
A better warning signal
The broker believes a more certain recessionary signal is when the 10-year treasury have less than a 50-basis point difference to the 90-day treasury.
Morgans noted that whenever this threshold is crossed, a US recession follows around 18-months later. But this timing has lengthened to two years since we entered into the 21st century.
"What we've seen recently is that US 10 year bonds fell below a level in which they were no more than 50 basis points above short rates. Now, long-term interest rates are actually below short-term interest rates," said Morgans.
"So, the question then is, does that forecast a US recession any time soon? So if the length of time between when the yield curve inverts and a US recession is about 2 years, even on my standard of it falling by 50 basis points, you don't have the possibility of a US recession until 2021."
Recession risks a worry for another time
That's a long time away, at least in share market terms. In the meantime, there is a lot of good returns investors can get from the ASX, in my view.
This is because central banks around the world, including Australian and the US, are opening the monetary spigots and flushing the system with excess liquidity.
This makes sense if indeed a recession is on the horizon and the US Federal Reserve will want to be in the front foot in managing a soft landing.
"The question is: what will the Fed do now to stop that growth recession, or shallow recession, or soft landing from turning into a hard one? We think this will be achieved through rate cuts, which have just begun," explained Morgans.
"Our model of the Fed Funds Rate suggests there will be at least three more rate cuts. So, we think the Fed will cut rates by 25 basis points each quarter until it gets down to 150 basis points.
"In 2021, we think the US economy will be in a growth recession or soft landing."
ASX stocks to buy for the yield inversion
Some of the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) stocks that Morgans is bullish on following last month's reporting season include Telstra Corporation Ltd (ASX: TLS), Wesfarmers Ltd (ASX: WES), Aristocrat Leisure Limited (ASX: ALL) and OZ Minerals Limited (ASX: OZL) – just to name a few.
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