Economists say the chances of an Australian recession are rising despite little apparent panic in bond markets amid heavy government spending and a global spike in borrowing to finance artificial intelligence investments.
Traditionally, as expectations of a recession rise, the yield curve inverts, meaning short-term borrowing is more expensive than longer-term rates. And yet, despite fears of a slowdown in the Australian economy, there has been no bond yield inversion. They briefly inverted in 2023.
While no major banks have yet to forecast a recession, HSBC Australian chief economist Paul Bloxham put the risk “at close to 50:50”.
“Not quite a recession but almost. We see growth close to stalling around the turn of the year [and] the risk of recession as having risen,” he said.
A recession is two consecutive quarters of negative GDP growth, and bond yields invert as lending money over the coming months or year becomes far riskier than lending over the next decade. But the gap between two- and 10-year bonds remains at 44 basis points, firmly in positive territory.
Part of the reason why, said UBS interest rate strategist Nic Guesnon, is heavy spending by so-called hyperscalers, largely American technology giants like Amazon and Meta, on funding data centre expansion. That demand is keeping the longer-term cost of borrowing high.
“The climb in bond yields is increasing the risk of recession, but it’s still not our base case,” said Guesnon. “Some investors think these hyperscalers are less risky than the sovereign market. In some ways, their credit fundamentals are a lot better than governments.”
Hyperscalers have raised more than $US200 billion ($287 billion) this year to fund construction of AI infrastructure around the world.
The conflict between the United States and Iran has also pushed oil prices above $US100 a barrel. As traders lose hope of a resolution to the war, they anticipate higher fuel prices will keep rates up long-term. Big spending, particularly by the Trump administration, is also keeping demand for long-term borrowing and the yield curve in check.
But many of those factors are not having a direct impact on the Australian economy, where GDP rose a modest 0.4 per cent in the June quarter. By comparison, the US economy is growing at a 2.2 per cent annualised pace.
The Reserve Bank of Australia’s decision last week to raise the cash rate a fourth time this year, putting it at 4.6 per cent – a 15-year-high – is also increasing the prospect that the economy will fall into recession.
“Households are facing high debt-servicing costs, while energy prices and other essential expenses are being pushed higher by disruptions to global trade and commodity markets. Whether this develops into a recession will depend largely on how long trade disruptions persist and how policymakers respond,” said Australian Retirement Trust economist Alexis Gray.
Despite these headwinds, most economists still believe Australia has the structural buffers to stave off a full-scale contraction.
“Though it cannot be entirely ruled out, the resilience in household incomes and the strength in business investment make an outright contraction unlikely,” said Westpac chief economist Luci Ellis.
The Australian economy rode a historic 29-year streak without a recession between the last downturn in 1991 and the pandemic in early 2020. Since then, the economy has struggled with high inflation and falling productivity.
Now, a surge in data centre construction, driven by the demands of cloud computing and AI, is creating significant spending, effectively providing a powerful economic floor just as consumer spending falters.
Relying on these tailwinds may not be enough, said EQ Economics managing director Warren Hogan. “Our historically low potential growth rate means it is much easier to slip into a technical recession than previously. In my assessment, the probability of a domestic financial crisis is the highest it has been since the late 1980s,” he said.