The threat of a recession doesn’t seem so remote anymore for investors in financial markets.
The yield on the closely watched 10-year Treasury fell so low Wednesday that, for the first time since 2007, it briefly crossed a threshold that has correctly predicted many past recessions. Weak economic data from Germany and China also fanned fears of a global slowdown.
That spooked investors, who responded by dumping stocks, sending the Dow Jones Industrial Average into an 800-point skid, its biggest drop of the year. The S&P 500 index dropped nearly 3% as the market erased all of its gains from a rally the day before. Tech stocks and banks led the broad sell-off. Retailers came under especially heavy selling pressure after Macy’s issued a dismal earnings report and cut its full-year forecast.
Investors have been plowing money into the safety of U.S. government bonds for months amid growing anxiety that weakness in the global economy could sap growth in the U.S. Uncertainty about the outcome of the U.S. trade war with China has spurred a return of volatility to the stock market in August — the Dow has dropped more than 5% and the S&P 500 is down more than 4%.
Economic data from two of the world’s biggest economies added to investors’ fears Wednesday. European markets fell after Germany’s economy contracted 0.1% in the spring due to the global trade war and troubles in the auto industry. In China, the world’s second-largest economy, growth in factory output, retail spending and investment weakened in July.
“The bad news for global economies is stacking up much faster than most economists thought, so trying to keep up is exhausting,” Kevin Giddis, head of fixed income capital markets at Raymond James, wrote in a report.
The S&P 500 fell 85.72 points, or 2.9%, to 2,840.60. The Dow sank 800.49 points, or 3%, to 25,479.42. The Nasdaq composite lost 242.42 points, or 3%, to 7,773.94. The Russell 2000 index of smaller company stocks slid 43.05 points, or 2.8%, to 1,467.52.
The losses come a day after stocks rallied when the Trump administration delayed tariffs on about $160 billion in Chinese goods that were set to take effect on Sept. 1.
While the market was falling Wednesday, President Donald Trump took to Twitter to again criticize the Federal Reserve for hampering the U.S. economy by raising rates “far too quickly” last year and not reversing its policy aggressively enough — the Fed cut its key rate by a quarter point last month. He also defended his trade policy, even though investors remain worried that the trade war between the world’s two largest economies may drag on through the 2020 U.S. election and cause more economic damage.
“We still see a substantial risk that the trade dispute will escalate further,” said Mark Haefele, global chief investment officer at UBS in a note to clients.
Traders tend to plow money into ultra-safe U.S. government bonds when they’re fearful of an economic slowdown, and that sends yields lower. The yield on the 10-year Treasury has dropped from 2.02% on July 31 to below 1.60%.
On Wednesday, it briefly fell below the two-year Treasury’s yield for the first time since 2007. Each of the last five times the two-year and 10-year Treasury yields have inverted, a recession has followed. The average amount of time is around 22 months, according to Raymond James’ Giddis. The indicator isn’t perfect, though, and has given false signals in the past.
After its early dip, the yield on the 10-year Treasury stood at 1.58%, even with the yield on the two-year. Meanwhile, the 30-year Treasury yield also hit a record low Wednesday.
Other parts of the yield curve have already inverted, beginning late last year. But each time, some market watchers cautioned not to make too much of it. Some say the yield curve may be a less reliable indicator this time because technical factors may be distorting longer-term yields, such as negative bond yields abroad and the Federal Reserve’s holdings of $3.8 trillion in Treasurys and other investments on its balance sheet.
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.
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. The 30-year yield sat at 2.04% Wednesday afternoon, above the 1.58% 10-year yield and the 1.56% two-year yield.
Some market watchers also say the yield curve may be less reliable an indicator this time because of technical factors that are distorting yields. Bonds in Europe and elsewhere have even lower yields than U.S. bonds and are negative in many cases. That’s sending buyers from abroad into the U.S. bond market, putting extra pressure downward on U.S. yields.
The Federal Reserve is also holding more than $2 trillion in Treasury securities, which it amassed to pull the economy out of the 2008 financial crisis and keep longer-term interest rates low.
Broader measures of the U.S. economy, meanwhile, are not pointing to an imminent downturn. The job market, consumer spending and consumer confidence all remain solid to strong.
“The only thing that’s flashing red or yellow right now is the yield curve,” said Jay Bryson, global economist at Wells Fargo.
Eric Winograd, senior economist at AllianceBernstein, said he expects growth to slow to an annual rate of about 1.5% in the second half of this year, down from a 2.5% pace in the first six months, but to avoid a recession.
Some investors believe an inverted yield curve is just a reflection of market worries that the economy is weakening and that the Federal Reserve needs to cut short-term interest rates. Others, though, say an inverted curve can help cause a recession itself by making lending less profitable for banks and cutting off growth opportunities for companies.
“For this reason, investors must not dismiss the current behavior in the fixed income market,” Natixis economist Joseph LaVorgna wrote in a research note.
Either way, some market watchers cautioned investors not to take the inversion as a panic signal and sell everything.
If someone’s first reaction to falling stock prices is to sell their stocks, they likely had too much of their portfolio in stocks to begin with. Drops like this are typical for stocks, and they’re the price investors have had to pay for better long-term returns than bonds historically.
“A lot of investors may look at this morning’s inversion and consider it an exit sign,” Mike Loewengart, vice president of investment strategy at ETrade Financial.
“Regardless of where the yield curve and market may take us, it’s critical for investors to stay the course and focus on maintaining a diversified portfolio aligned to their long-term goals.”