Fragile market slides again
Trump rhetoric sows confusion; bonds send warning about possible slowdown
Stocks fell Tuesday after President Donald Trump sowed confusion over the status of a truce in the trade war between the United States and China, while the bond market, often considered a haven for investors, sent a stark warning about expectations for an economic slowdown.
The S&P 500 dropped more than 3 percent, with economically sensitive financial and transportation stocks sliding.
The warning from the bond market came through what is known as the yield curve, the difference between interest rates on short-term U.S. government bonds, such as two-year notes, and longer term bonds, such as the 10-year Treasury.
As wary investors seek security, they buy long-term Treasury bonds, pushing prices up and pushing down yields, which move inversely to prices. The yield on the two-year note tends to move along with the short-term rates controlled by the Federal Reserve; both have risen this year.
The gap between the two-year and 10-year yields has decreased to less than 0.12 percentage points — the lowest it has been since before the financial crisis. Many ana-
lysts say it could soon fall below zero, a phenomenon known as an “inversion.”
This might sound like so much jargon important only to bond market geeks. But it matters.
“The inversion has always preceded the recession so you can’t just poohpooh it and say this is some crazy forecaster who is telling us the world is going to end,” said Vinay Pande, head of trading strategies at UBS Global Wealth Management’s Chief Investment Office.
In the past 60 years, every recession has been preceded by an inverted yield curve, according to research from the San Francisco Fed. Curve inversions have “correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession,” the bank’s researchers wrote in March.
That does not mean the next recession is imminent — it can take a year or two for an inverted yield curve’s recession warning to come to fruition. Nor does it mean that the stock market rally will immediately come to an end. The yield curve also narrowed earlier this year, and the stock market mostly ignored it then.
But this time, with investors already worried about the global economy and the effect of the trade war on growth, the warning is being seen in a different light. The United States’ economy is growing at a healthy clip, but China’s is growing at its slowest rate in a decade. The world’s third-largest economy, Japan, shrank during the third quarter, as did Germany’s.
Stocks also fell Tuesday after Trump added to uncertainty about the trade war related agreement he reached with China’s president over the weekend by tweeting a warning to China and referring to himself as “Tariff Man.”
The S&P 500, which had climbed more than 1 percent Monday following news that the two countries had agreed to a standstill on additional tariffs, was down by more than 2 percent in afternoon trading.
The financial sector was one of the hardest hit segments of the market Tuesday. A flattening yield curve hamstrings profitability for banks, which benefit from a wide difference between short-term rates, which they pay to borrow, and long-term rates, which they charge their customers.
Stocks of so-called cyclical companies — which are heavily reliant on economic growth for sales and profits — also slumped Tuesday. Shares of airlines such as American Airlines, Southwest and Delta Air Lines slipped. The S&P 1500 index of automakers and auto parts — another highly cyclical sector — fell more than 2 percent.
There are several reasons the flattening of the yield curve is seen as such a good predictor of recession.
Typically when an economy is in good health, yields on longer-term Treasurys are higher than those on shorter term government bonds, reflecting investor expectations that economic growth, and some inflation, will continue in coming years. When investors become less sure of that the economy and prices will continue to rise, and yields on longer term bonds rise slowly, or even fall.
That has been the case lately. Despite solid domestic economic growth unemployment near 50-year lows, the yield on the 10year Treasury note tumbled to 2.94 percent Tuesday, down from 3.25 percent in September.
And other markets have also been sending some signals about softness in the global economy. U.S. benchmark crude oil prices have plummeted more than 25 percent since the end of September.