U.S. stocks plummeted Wednesday after the inverted yield curve, one of the most reliable indicators of a recession, sparked a new wave of investor fears.
For the first time since 2007, the yields on short-term U.S. bonds eclipsed those of long-term bonds. This phenomenon, which suggests investors’ faith in the economy is faltering, has preceded every recession in the past 50 years. It isn’t a sure thing, but it’s one of the more reliable signs that something is amiss in the economy. Recessions typically come within 18 to 24 months after an extended yield curve inversion, according to research from Credit Suisse.
The warning sign dealt another blow to markets, in a time of the year that’s notoriously tough on stocks. The Dow Jones industrial average falling more than 700 points by midday trading. The Standard & Poor’s 500-stock index was down about 2.8 percent, and the tech-heavy Nasdaq composite index was down more than 3 percent. Ten of the 11 market sectors were in the loss column Wednesday, with energy, consumer staples and financial services leading the way.
Bank stocks slumped off the news. Bank of America and Citigroup saw their shares sink more than 4 percent, and JPMorgan’s shares fell 3.6 percent. Gold, a safe haven for investors, rose. And the influx of investors scrambling for safety pushed U.S. 30-year Treasury yields to their lowest level ever.
“The stars are aligned across the curve that the economy is headed for a big fall,” said Chris Rupkey, chief financial economist at MUFG Union Bank. “The yield curves are all crying timber that a recession is almost a reality, and investors are tripping over themselves to get out of the way.”
Darkening skies overseas gave investors more to worry about. New data indicated Germany was slipping into recession with the country’s economy shrinking 0.1 percent between April and June. If it experienced another contraction during this quarter, Germany officially would meet the definition of a recession.
Officials blamed the drop-off on the U.S.-China trade war and the looming threat of a hard Brexit. The European Stoxx 600 benchmark was down nearly 6 percent in midday trading.
Meanwhile China reported more signs of a weakening economy Wednesday, with high unemployment and factory output falling to a 17-year low. The report fed fears about a broader global slowdown as the trade conflict appears to be stalling some of the world’s most powerful economies.
Peter Navarro, the White House senior trade adviser, told Fox Business that the panic over the yield curve inversion was unjustified, and that Federal Reserve policy was the real cause of the market’s instability.
“The biggest problem we’re fighting right now at the White House is the Federal Reserve’s interest rate policy. We lost almost a point of growth in Q2 simply because the Fed had raised the interest rates too far, too fast,” Navarro said. “The inversion of the yield curve is sending yet another signal that the Fed needs to lower interest rates by 50 basis points as quickly as possible.”
Several factors have contributed to the market turbulence in recent sessions, including China’s threat to devalue its currency, massive protests in Hong Kong that could prompt a response from the Chinese government, an escalation of the U.S.-China trade war and the flight to bonds.
The trade roller coaster has fostered a feeling of uncertainty among American businesses, making it more difficult for companies to make long-term plans. The uncertainty has been felt in stock prices. The Dow is about 5 percent off its all-time high of one month ago. Trade concerns have now worked its way to the U.S. Treasury bond market.
“The big concern is around trade,” said Dan Ivascyn, group chief investment officer at Pimco. “The longer we remain in limbo, the more damage to the global economy. You already have a fragile global economy, and with this trade tension you are beginning to see people shift into safer assets with almost complete disregard for what they are earning on those assets.”
The spate of economic warning signs across the globe followed a rare moment of easing Tuesday in the U.S.-China trade war, after the White House announced that tariffs on certain consumer goods — such as laptops, cellphones and toys — would be postponed a few months to give shoppers and companies a break during Christmas shopping. Some of the tariffs on the remaining $300 billion in Chinese goods will still go into effect Sept. 1 as planned, while the items covered under the delay won’t be affected by tariffs until Dec. 15.
“Just in case they might have an impact on people, what we’ve done is delayed it so they won’t be relevant for the Christmas shopping season,” President Trump told reporters Tuesday.
It was the first time Trump has publicly acknowledged that American people and businesses bear some of the burden from his tariffs.
The delay offered a glimmer of hope in an otherwise grim outlook in U.S.-China trade policy and was announced after a phone call between trade negotiators, which Trump lauded as productive. Chinese officials are planning to come to the United States in September to continue talks.
“The delay impacts around half of the $300 billion of imports and quite clearly focuses on popular consumer products that could have made the Christmas shopping period a lot more expensive for American consumers,” Craig Erlam, an analyst with OANDA, wrote in a note to investors Wednesday. “Trump’s decision to protect consumer’s from tariffs in such an important period makes a lot of sense, but it also recognizes that 2020 could become much more expensive for them if progress is not made.”
Some White House officials have become increasingly concerned about the strength of the economy heading into the 2020 election, and they have pressed the Federal Reserve to cut interest rates, which they believe will free up more money for investing.
Trump sought in his first two years to juice economic growth through a combination of tax cuts, spending increases, regulatory changes, and low-energy costs, but many critics said the steps he took were just short-term patches that did little to fix problems in the economy. Trump has said repeatedly that the economy is now the strongest in American history, but there are numerous signs that this is not the case.
The government is set to spend almost $1 trillion more than it brings in through revenue this year, an unusual occurrence when the jobless rate is low. Parts of the manufacturing sector have shown signs of contracting in recent months, and business investment has stalled.
The stock market has become increasingly volatile, frequently whipsawing up or down based on any news related to trade discussions between the White House and China. Trump and top advisers have ramped up pressure on the Federal Reserve to slash interest rates, a demand that past presidents have refused to make out of fear of tainting the central bank.
A drop in the closely watched 10-year U.S. Treasury bond is a sign that investors are heading away from the risk of stocks and toward the safety of long-term bonds. Yields drop when bond prices rise. Some European countries also have negative bond yields. That means people are paying governments to hold their money for them. Historically, people buy government bonds and expect interest payments on those bonds as a reward for lending the government money.
David Kass, a finance professor at the University of Maryland, cautioned that the yield curve may not be an accurate predictor of a recession under current conditions. Kass said several recessions in the past few decades have been preceded by Federal Reserve interest rate increases.
That is not the case currently.
Kass said negative bond yields in Europe, in which investors receive nothing for their money, may be pushing investors into U.S. Treasurys.
“Foreign investors may be buying long-term U.S. Treasurys in order to earn a positive return,” Kass said. “This would exert downward pressure on the yield of long-term U.S. Treasury securities.”