Stock market turbulence is showing no signs of easing.
Every sector of the ASX is in the red today, falling more than 1 per cent and reportedly wiping $50 billion of gains off the local bourse within minutes.
The benchmark S&P/ASX200 index was down 136.8 points, or 2.07 per cent, to 6,459.1 points at 1200 AEST on Thursday while the broader All Ordinaries was down 137.9 points, or 2.07 per cent, to 6,539.6 points.
The slide comes off the back of Wall Street’s overnight drops of nearly 3 per cent across all the major US indices.
It comes barely a week after Wall Street and the local bourse were both in freefall, which saw the ASX hammered for a second day straight on 6 August.
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And now, a major indicator of a US recession has flashed red, which sent the Dow Jones tumbling so much last night that it posted its biggest one-day point drop since October.
Why have stock markets tanked this time?
It’s entirely wrapped up in something called the US Treasury yield curve, which inverted overnight.
Historically, when it’s inverted itself, it’s a sign of an incoming recession.
An ‘inverted yield curve’ happens when interest rates on short-term bonds are higher than the rates paid by long-term bonds.
When the yield curve inverts itself, it’s a sign people are so worried about their short-term investments that they’re hedging their bets on longer-term investments instead.
The reason why everyone is so alarmed comes down to the prolonged fall-out of the US-China trade war.
“The uncertainty around US tariffs is slowing the Chinese economy which in turn is dragging on Germany given its high exposure to manufacturing,” Oliver explained. All of this is weighing on US business confidence, which is currently facing “immense uncertainty” about supply chains and therefore where to invest.
Other global events, such as Brexit and the Hong Kong situation. aren’t helping, either, Oliver added. All of this is driving share markets down, as well as bond yields, commodity prices, and the Aussie dollar.
So people are worried, and that’s making long-term investments more attractive, hence inverting the US Treasury yield curve.
Unfortunately, the curve has inverted itself before every single US recession since 1955, and is therefore a predictor of a chance of a recession.
What’s the US Treasury yield curve got to do with Australia?
Investors are alarmed because it’s a sign that the US is creeping closer to a recession – which of course doesn’t spell very good news for the global economy.
And a weak global economy means risk for the domestic economy.
“Australia is not in the trade war but anything that weakens global growth threatens our exports and confidence,” AMP Capital chief economist Shane Oliver told Yahoo Finance.
“So we are naturally seeing a fall in the Australian share market too… Just like we did last year when the trade war started.”
Does this mean the US is going to go into a recession?
The inverted US Treasury yield curve reflects the pessimism of investors, Centre for Future Work director and economist Jim Stanford told Yahoo Finance.
And the US yield curve in question, which maps the spread between 2-year and 10-year bonds, is only in positive territory by about 0.002 per cent, according to Oliver.
“So it’s likely it will go negative again,” Oliver said, adding that other US yield curves were already negative and signalling a rising risk of recession.
Sometimes, however, yield curves are false signals.
Other elements that need to be there for a recession to happen, such as the US Federal Reserve slamming the brakes on interest rate moves, high inflation, high debt growth and excessive investment that has to be unwound, aren’t there.
While it appears that the possibility of a US recession has moved closer to reality, many experts still don’t think it’ll go that far – and one man will be key to avoiding this scenario.
“The risk of recession in the US and globally has gone up but it's still not likely as central banks will ease further, and I suspect at some point Trump will crack and negotiate with China to resolve the trade war,” Oliver said.
“He knows that US presidents don’t get re-elected if there is a recession and rising unemployment prior to the election.”
So is Australia close to a recession?
With stock market jitters a weekly occurrence, it’s no wonder this question is at the tip of everyone’s lips.
However, the good news is that an Australian recession is largely not on the cards, according to economic experts.
“A recession in the US alone would not necessarily throw Australia into recession too,” Stanford said.
US doesn’t buy that many Australian man-made products; the US is Australia’s fifth-largest export market, trailing China, Japan, South Korea, and India.
But the problem doesn’t just lie with the US, said Stanford.
“China’s prospects are also facing uncertainties. If we end up with an international recession, Australia would certainly be caught in the turmoil.”
UNSW Business School associate professor Elvira Sojili acknowledged that while there was “a risk” of a recession coming, it would still be a long way off.
“It is not around the corner and certainly it will not be related to the temporary drops in the stock prices,” Sojili said.
Everything should be kept in perspective: this share market plunge isn’t the be-all and end-all, she added.
“While the US slump is important, the economic indicators that are more important are the slowdown in the Chinese economy and what is happening to the Australian housing market.
“These two are much bigger issues here than the temporary drop in the US stock market.”
The economy isn’t looking great
While experts aren’t yet at the point of predicting a recession Down Under, we’re on shaky ground.
Australia escaped the global financial crisis of 2009 – but according to Stanford, this is going to be harder to achieve next time round.
Back then, demand for Australia’s resource exports were strong; then-treasurer Wayne Swan implemented an effective stimulus package; and the RBA cut interest rates.
“Those advantages are not really available now,” Stanford said.
“Demand and prices for most resource exports are much weaker than in 2009, the current government is not disposed to large stimulus spending, and the RBA doesn’t have much room to cut.
“Moreover, business investment is extremely weak: down by one-third as a share of GDP since 2012. So growth is already shaky, before any side-effects of global instability.”
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