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Stocks Fall as Bond Yields Flash a Recession Warning

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08/14/2019 | 02:19pm EDT

By Corrie Driebusch, Britton O'Daly and Paul J. Davies

U.S. stocks slumped and Treasury markets sent a new recession signal Wednesday after weak German and Chinese economic data stoked fears of an impending global slowdown.

The Dow Jones Industrial Average dropped about 600 points, or 2.3%, and earlier declined more than 750 points, while the yield on the U.S. 30-year Treasury bond fell to a record low.

The drops erased the optimism sparked a day earlier when the Trump administration abruptly suspended plans to impose new tariffs on goods from China and suggest the volatile swings that have defined trading in August are showing no signs of easing.

Trade tensions between the U.S. and China, uncertainty about the Federal Reserve's interest-rate policy and signs of slowing economic growth have spurred weeks of turbulence that have rippled through the stock, bond and currency markets since major stock indexes hit all-time highs in mid-July.

In the Treasury market, the yield on the U.S. 30-year Treasury bond touched 2.018%, according to Tradeweb, below the previous intraday low of 2.094% in July 2016. The 30-year is the longest type of U.S. government debt and one of the most sensitive to changes in expectations for long-term growth and inflation.

Meanwhile, yields on the 10-year Treasury note briefly fell below two-year yields for the first time since 2007. This kind of inversion between short and long-term yields is viewed by many as a signal that a recession is likely in the future.

"Whether we go into recession now or we don't, it's not a good sign," said Michael Farr, president of investment firm Farr, Miller & Washington. "You're going to see investors temper their enthusiasm more seriously today."

Timing is everything, though, and markets tend to keep moving higher immediately following a yield-curve inversion. Since 1978, the S&P 500 has risen 13%, on average, from the first time the spread inverts on a closing basis to the beginning of a recession, according to Dow Jones Market Data.

This latest inversion, though, is particularly concerning to some investors given it comes on the heels of the Fed cutting short-term rates last month. Many traders and analysts are now looking for additional intervention by the Fed to extend the economic expansion in the U.S.

The Fed's preferred measure of recession risk is the difference between 10-year and three-month yields, which have consistently flashed warnings since late May.

Expectations for further rate cuts jumped Wednesday morning, with Fed-funds futures showing a market-implied probability of nearly 20% that the central bank cuts rates by 50 basis points in September, up from 4% a day ago.

"The Fed doesn't have the cure for an economic slowdown or recession," said Kristina Hooper, chief global market strategist at Invesco. "But I do think the Fed has the antidote for the stock-market selloff."

Though U.S. Treasury yields have fallen precipitously, they remain higher than the debt on most developed countries around the world. Yields are negative in Japan and much of Europe, sending investors to piling into U.S. bonds, which has pushed prices higher and yields lower.

"Investors globally have no where else to go for yield," said John Brady, managing director at brokerage R.J. O'Brien & Associates.

The S&P 500 and Nasdaq Composite declined 2.3% and 2.6%, respectively, after the indexes rose by more than 1% Tuesday. The volatility puts the S&P 500 on track for its sixth swing of at least 2% this year and its sixth consecutive move of at least 1%. The benchmark index has dropped roughly 6% from its closing record last month.

All 11 sectors in the index declined in Wednesday's sessions, led by energy stocks, which slumped as the price of U.S.-traded crude oil dropped 3.9%. Bank stocks also underperformed as lower yields can weigh on their lending profitability. Citigroup fell more than 5%, while Bank of America dropped 4.5%.

After rallying Tuesday on the tariff reprieve, shares of retailers tumbled as Macy's lowered its earnings outlook, a troubling sign heading into the key back-to-school and holiday seasons. The department-store operator's shares fell 13%, dragging down shares of Kohl's and Nordstrom as well.

Market swings tend to be exaggerated when trading is slow. Stock- and bond- trading volumes have been lower than normal this August, JPMorgan Chase analysts said in a recent note.

"Volumes are actually not that prevalent at the moment because yesterday the market did the opposite, so people are at a standstill position," said Mohit Bajaj, director of ETF trading solutions at broker WallachBeth Capital LLC. "We'll see what happens in September when people are back from vacation."

It isn't unusual to see swift drops this time of year. In August 2011, the stock market tumbled after the Standard & Poor's downgraded U.S. Treasury debt, and in August 2015, U.S. stocks tumbled in tumultuous trading after Beijing's unexpected move to devalue its currency.

Elsewhere, European stocks fell after data showed the German economy shrank in the second quarter. The Stoxx Europe 600 dropped 1.7%, while the German DAX fell 2.2%.

Germany's economy contracted by 0.1% in the second quarter due to further declines in exports, and the latest data mean that average quarterly growth has been zero since the third quarter of 2018, according to ING.

The data put pressure on the German government to stimulate the economy through tax cuts or public spending, and the yield on the 10-year German bund touched a fresh record low of minus 0.645%, according to Tradeweb.

The debilitating effect of trade tensions also was visible in Chinese data, as value-added industrial production in the country grew 4.8% in July, significantly lower than the 6.3% increase in June and below expectations of 5.9% growth.

Still, Asian stocks rallied on the tariff delay, with shares in Shanghai up 0.4% and Japan's Nikkei up 1%. Hong Kong's Hang Seng added nearly 0.1% as the city continued to struggle with protests and violence.

Caitlin Ostroff contributed to this article.

Write to Corrie Driebusch at corrie.driebusch@wsj.com and Paul J. Davies at paul.davies@wsj.com

Stocks mentioned in the article
ChangeLast1st jan.
DAX -1.15% 11611.51 Delayed Quote.11.25%
DJ INDUSTRIAL -1.98% 25725.99 Delayed Quote.12.54%
HANG SENG 0.52% 26190.11 Real-time Quote.0.81%
NASDAQ 100 -2.75% 7485.156432 Delayed Quote.21.08%
NASDAQ COMP. -2.62% 7777.292331 Delayed Quote.19.79%
NIKKEI 225 0.40% 20710.91 Real-time Quote.3.31%
S&P 500 -2.10% 2860.35 Delayed Quote.16.66%
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