BOND MARKET ALARM
‘Inverted yield curve’ sends Dow down 800 points; event often signals future recession
NEW YORK — The bond market sounded its loudest warning bell yet of recession on Wednesday, when the yield on the 10-year Treasury briefly fell below the two-year yield, sending the Dow down 800 points.
The yield event is rare: Investors usually demand more in interest for tying up their money in longer-term debt. When yields get “inverted,” market watchers say a recession may be a year or two away.
An inverted yield curve has historically been a reliable, though not perfect, predictor of recession. Each of the last five recessions was preceded by the two- and 10-year Treasury yields inverting, according to Raymond James, taking an average of about 22 months for recession to hit. The last inversion of this part of the yield curve began in December 2005, two years before the Great Recession tore through the global economy.
This latest inversion is the result of a steep slide in long-term yields as worries mount that President Donald Trump’s trade war may derail the economy. Discouraging economic data from Germany and China, two of the world’s largest economies, also unnerved investors on Wednesday.
The temporary flip in yields touched a nerve on Wall Street.
The Dow Jones Industrial Average fell 800 points, or 3%, to 25,479. The S&P 500 lost 85 points, or 2.9%, to 2,840. The Nasdaq lost 242 points, or 3%, 7,773.
The bond market has been much more pessimistic about the health of the economy in recent months than the stock market, which set a record high just last month.
If all the talk about yield curves sounds familiar, it should. Other parts of the curve have already inverted, beginning late last year. But each time, some market watchers cautioned not to make too much of it.
In December, for example, the yield on the five-year Treasury dropped below the two- and three-year Treasury yields. It
wasn’t a big deal at the time because academics and economists pay much more attention to the relationship between three-month yields and 10-year yields.
When the three-month yield rose above the 10-year yield earlier this year, it drew more attention. But traders said the inversion would need to last a while to confirm the warning signal, and they pointed out that the widely followed gap between the two-year yield and the 10-year yield was still positive.
Now, that tripwire has been crossed too, and the three-month Treasury yield remains above the 10-year yield.
One of the biggest concerns is that all the uncertainty around the U.S.-China trade war — where the world’s hopes of a resolution can rise and fall with a single tweet or statement — may cause businesses and shoppers to wait things out and rein in their spending. Such a pullback could hurt corporate profits and start a vicious cycle where companies cut back on hiring, leading to further cutbacks in spending and more damage for the economy.
The concerns have sent the 30-year Treasury yield sinking, and it touched a record low Wednesday. But it remains above shorter-term yields, which means not all of the yield curve is inverted and offers a bit of solace.