Wall Street plunged Wednesday, with the Dow Jones Industrial Average falling 750 points, or 2.85 percent, after bond markets flashed a troubling indicator of an impending recession. The S&P 500 fell by 2.6 percent, and the Nasdaq slumped by 2.9 percent.
The steep declines came after the yield on the benchmark 10-year Treasury note fell below the 2-year rate for the first time since 2007. That phenomenon, known as an inverted yield curve, has predicted every recession since the 1960s, and is a demonstration of mounting concern among investors that the sluggish global economy will take its toll on U.S. economic growth.
When bond yields drop this low, it is a firm signal of the income appetite of investors, who shift towards less risky assets that do not expose them to market vulnerability.
The yield curve marks the difference between how much it costs to borrow over the short term versus the long term. Banks borrow money at a lower short-term rate and then offer those funds to borrowers at a higher rate. When that dynamic is thrown off, it means less profit for banks, leading to tighter lending — and that, in turn, means companies can put their spending plans on hold, freeze hiring, or even lead to layoffs.
Consequently, shares in banks took the biggest hit, with Citigroup down by just over 5 percent and JPMorgan falling almost 4 percent.
While the time frame from yield curve inversion to recession can vary — it has taken anywhere from two to six quarters after an inversion for a recession to occur — all of the past recessions have been preceded by inversions of the yield curve.
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“It’s a dangerous and upsetting harbinger of the future of the economy,” said Dan North, chief economist at Euler Hermes North America, when the curve flattened out earlier this year. “Typically, when the yield curve inverts for even a short period of time, we enter a recession about a year later,” he said.
Ongoing geopolitical turmoil, including President Donald Trump’s monthslong trade war with China and the still-unresolved crisis over Brexit, remains a key threat to the historic economic expansion in the U.S.