Dow Jones Industrial Average Slides as Treasury Market's Recession Warning Gets Louder - Barron's

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The Treasury market has broadcast a new recession warning—and the Dow Jones Industrial Average doesn’t like it.

For the first time since the financial crisis, the benchmark 10-year Treasury yielded less than the two-year note Wednesday morning. That pricing anomaly is known as a “yield curve inversion,” and is seen as an indicator of recession. What’s more, the 30-year Treasury yield has touched a record low of 2.06%.

Investors found more reasons to worry about growth overnight, thanks to weak Chinese economic data and news that the German economy contracted in the second quarter. U.S. stock futures were lower, with the S&P 500 on track to open with a 0.9% decline and Dow Jones Industrial Average futures down 269 points, or 1%, at 7:05 a.m. on Wall Street.

In normal times, investors demand higher yields to buy long-term bonds. This yield premium compensates investors for the opportunity cost of tying up money for longer, and the greater potential for price volatility in long-term debt. Thanks to standard bond math, long-term bonds’ prices are more sensitive to interest rates than shorter-term debt. Their values are also eroded more by inflation.

So when long-term yields fall below short-term yields, it shows that investors think interest rates might fall quickly, and that inflation should remain low—two things that happen in recessions. On a basic level, it means that investors would rather lend long-term than short-term, which indicates a dearth of near-term investment opportunities and economic growth.

This yield curve inversion certainly isn’t the first or best recession warning displayed by the U.S. Treasury market; the 10-year yield has been below the three-month yield for months, another unusual relationship. That part of the curve has historically been more reliable as a recession indicator than the gap between the two- and 10-year yields, and is used by the Federal Reserve Bank of Cleveland in its economic projections.

But the 10-year yield often falls below the two-year yield in the run-up to recessions as well, and some strategists had used the lack of that inversion to argue that there was still plenty of time before a downturn.

Wednesday morning’s yield-curve inversion is part of a feedback loop between economic growth fears and government bond yields. Investors are concerned about economic growth, and expect global central banks to cut rates as a result. That expectation has sent them into long-term government bonds, pushing yields down. And falling yields only exacerbates worries about growth.

Write to Alexandra Scaggs at alexandra.scaggs@barrons.com

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https://www.barrons.com/articles/dow-jones-industrial-average-slides-as-treasury-markets-recession-warning-gets-louder-51565781879

2019-08-14 11:24:00Z
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