The outlook for the Australian economy is increasingly uncertain, as odds of The Lucky Country’s first recession in more than two decades are increasing. Data from the Australian Bureau of Statistics reveal that wage growth during the fourth quarter of 2014 matched a record-low pace.

The unemployment rate Down Under is at a 12½-year high of 6.4%, and it’s much worse in industrial areas such as Broadmeadows, near Melbourne, where joblessness is up to 27%. The Reserve Bank of Australia’s (RBA) Commodity Price Index for February 2015 showed a 27% year-over-year decline for prices of the country’s key exports.

Although most analysts see only an outside chance of a recession in Australia, the probability of a contraction rose to 18% in February from 11% in August 2014, according to a Bloomberg survey of 11 analysts.

In February the RBA cut its benchmark overnight cash rate to 2.25%, lower than it was during the Global Financial Crisis of 2008–09, in a dramatic turn from late 2014, when most economists were expecting the central bank to hike rates in 2015.

And 10-year Australian government bond yields are lower than they were during the 1930s, a period defined by a deflationary spiral that became the Great Depression.

A major problem for the RBA is that interest-rate-sensitive sectors of Australia’s economy don’t need more stimuli.

Indeed, cutting borrowing costs from here risks inflating what’s already being described as a “bub-ble” in housing.

Broadmeadows is home to a Ford Motor Company plant that’s closing because what was once a record-high Australian dollar made operations untenable. That decision was made while the commodity boom was still buoying The Lucky Country.

It’s a poster child for suburbs dominated by manufacturers that received little benefit from China’s surging demand for raw materials and at the same time suffered the impact of a record-high currency.

According to a recently published discussion paper on the topic, the RBA remains confident that lower interest rates will enable Australian households to withstand another downturn akin to the Global Financial Crisis.

In a simplified “stress test” to assess the ability of households to withstand major shocks such as recession, RBA modeling revealed “a high level” of resilience among Australian households and forecast limited losses for lenders.

Although household debt rose from around 40% of total income in the 1980s to 150% by the mid 2000s, that didn’t make households more fragile.

That’s because debt is concentrated among households best placed to service it, the discussion paper found.

According to RBA researchers, “The model suggests that through the 2000s, the household sector remained resilient to scenarios involving asset price, interest rate and unemployment rate shocks, and the associated increases in household loan losses under these scenarios were limited.”

And in a scenario of rising unemployment and falling asset prices, similar to what Australia experienced during the GFC, lower interest rates were able to prevent loan defaults.

“By reducing debt-servicing costs,” the researchers found, “the interest rate reduction increases financial margins and thus makes borrowers less likely to default.

“Australia’s experience during the Global Financial Crisis suggests that it is not implausible. With the assistance of accommodative monetary policy, the Australian economy was able to absorb a shock of similar magnitude during the crisis with limited aggregate impact on household loan performance.”

These are encouraging conclusions assuming, of course, that the researchers contemplate no additional interest-rate cuts by the RBA. 

In this context, we’ll continue to assess our exposure to Australia-based stocks with an eye toward limiting downside risk. 

In other words, we’re ready to exercise our sell discipline should underlying business fundamentals for our Portfolio Holdings deteriorate.