Updated December 05, 2018 16:22:23

Photo: The local share market is being led down by the major banks, telcos and health care stocks. (AAP: Tracey Nearmy)

Australian shares have dropped sharply, following an $US820 billion wipe-out on Wall Street triggered by recession fears surrounding the US economy.

The benchmark ASX 200 rallied late to close 0.8 per cent lower at 5,668, after initially sliding a sharper 1.7 per cent at the open.

The broader All Ordinaries index had fallen by a similar level to 5,749 points.

Ongoing uncertainty over the temporary US-China "trade truce" has also weighed on markets around the world — in particular, conflicting messages from both nations about what was actually agreed.

The Trump administration said China would eliminate tariffs on imported US cars and "immediately" start buying a "very substantial" amount of American goods.

However, Beijing has not confirmed any of these trade concessions.

We shouldn't underestimate the seriousness of the trade war unfolding between the US and the rest of the world, writes Stephen Kirchner.

Stock markets across the Asia-Pacific also suffered heavy falls initially, but have clawed back some losses.

The biggest recoveries were seen in Japan's Nikkei (-0.4pc), South Korea's KOSPI (-0.5pc) and the Shanghai Composite (-0.6pc). They had earlier fallen between 1 and 1.5 per cent respectively.

New Zealand's NZX 50 (-1.2pc) and Hong Kong's Hang Seng (-1.5pc) indices are still trading sharply lower.

The Australian dollar is trading below 73 US cents after the latest GDP figures revealed that annual economic growth was far weaker than expected — (2.8pc, versus market expectations of 3.3pc).

The local currency had risen as high as 73.54 US cents at its early-morning peak but was worth 72.84 US cents at 4:20pm (AEDT).

A link between bonds and recessions

The weaker sentiment in Australia was primarily driven by worries arising from the US Treasury bond market overnight.

Analysts have pointed specifically to the narrowing difference between short-term (two-year) interest rates, and longer term (five and 10-year) bond yields.

Rising interest rates are putting global stock markets under pressure. Will they eventually crush them?

The long-term rates are supposed to be higher to reflect expectations of continued economic growth and the opportunity cost of parking money for long periods of time.

But the return on two-year bonds (2.8pc) has now surpassed the five-year rate (2.79pc), and is not far behind the 10-year yield (2.92pc).

A flattening or "inverted" yield curve — in which short-term rates are higher than long-term rates — can signal an economic slowdown.

"In the past, that has been a signal that suggested a recession could be in the offing," said Craig James, CommSec's chief economist.

Historically, this "inversion" trend occurred prior to the US recessions of 1990, 2001 and 2007, under the Bush Sr and Bush Jr presidencies.

However, Mr James said "there is nothing fundamental going on with the [US] economy ... [which is] still very much in good shape".

"Inflation is under control, the US unemployment rate is at the lowest levels we've seen in the order of 50 years … and business conditions are close to record highs."

He said the higher short-term rates might be a sign of the Federal Reserve hiking interest rates too quickly.

The Fed has already raised the US benchmark interest rate three times this year, and markets are pricing in an 80 per cent chance it will announce another rate hike this month.

Topics: stockmarket, markets, currency, business-economics-and-finance, australia

First posted December 05, 2018 10:17:25