In a flat yield curve, there's little difference between short-term yields and long-term yields. But when investors are anxious that growth will fall off sharply, perhaps as a result of the Federal Reserve pushing short-term rates higher, they're willing to accept less in interest for a Treasury maturing far in the future.
World stocks tumbled to one-week lows on Wednesday, as declines by long-dated USA bond yields and a renewal of trade concerns stoked fears of a downturn in the world's biggest economy, the United States. Still, investors were nervous about an inversion of the curve between three-year and five-year U.S. Treasury notes and between two-year and five-year notes. Concerns about global growth slowing and higher interest rates, coupled with simmering trade-war tensions, are thought to be behind the inversions. An inversion in that part of the curve has preceded each of the last seven recessions.
Typically, bonds with longer maturities offer higher yields, as investors demand greater compensation to keep their money locked away for longer time periods.
Investors are increasingly concerned, however, by a flattening of the spread between two- and 10-year Treasurys, a more fundamental benchmark of market health.
On Monday, the difference between the two-year and 10-year Treasury yields dropped to just 0.15 percent, its lowest level since prior to the last US recession.
Between 1988 and 2008, inversions of the 2s and 10s were followed by recessions about 24 months later, according to Wells Fargo, cited by CNBC.
-China trade talks. The inversion of a portion of the Treasury yield curve for the first time since 2007 reinforced the impression that markets are approaching the end of the current cycle. It has preceded all nine USA recessions since 1955, with a lag time ranging from six months to two years.
An inversion implies that investors are selling short-dated bonds faster than their long-dated counterparts, because bond prices fall as yields rise. It's a sign investors are unmoved by a potential slowdown in the Federal Reserve's interest-rate-hiking program.
The Dow Jones Industrial Average fell 799.36 points, or 3.1 percent, to 25,027.07, the S&P 500 lost 90.31 points, or 3.24 percent, to 2,700.06 and the Nasdaq Composite dropped 283.09 points, or 3.8 percent, to 7,158.43. U.S. President Donald Trump on Tuesday held out the possibility of an extension of the 90-day trade truce with China but warned he would revert to tariffs if the two sides could not resolve their differences.
"This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that", Ian Lyngen, the head of united rates strategy at BMO Capital Markets, told CNBC.
On December 4 the yield curve signaled caution and, along with worries about global trade and interest rates, it helped send the stock market to one of its worst days of the year.
Whether that means a recession is likely in the next few years depends on numerous factors, but it's a stark sign of things to come from a usually emphatic bellwether.
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