It was always implicit in the Federal Reserve’s decision on Wednesday that all interest increase in 2019 were off the table and that the central bank would end its $50 billion a month balance sheet run off in September. Yeah, lower interest rates are a boost to stock prices–unless they indicate that a recession is just around the corner.
Today stocks sold off as the yield curve for Treasuries inverted. The day ended with the yield on the 10-year Treasury at just 2.44%–that’s the same yield as shown by the 3-month note. When a borrower gets the same of less for lending to the government over 10 years as for extending a loan for 90 days, its a sign that markets are seeing a slowdown ahead. The slowdown would result in interest rates cuts from the Federal Reserve bringing the yield of longer duration Treasuries below those for short duration Treasuries since the longer duration debt would climb in price (which would drive down yields) if a recession caused interest rate cuts from a central bank looking to support economic growth.
The 2-year Treasury, often the maturity that is most sensitive to changed in Fed policy, closed at a yield of just 2.31% today–way below the 2.44% yield on the 3-month note. The 5-year Treasury closed with a yield of 2.24%.
Now investors and traders know that an inversion of the yield curve isn’t always a reliable indicator of a recession, but there was enough negative economic news from other fronts to support fears of a recession. The latest report from the German Purchasing Managers Index was even weaker than expected–and the yield on the 10-year German bond fell below 0%. The manufacturing sector in Japan contracted for a second straight month. And back home, the Purchasing Managers Index for the manufacturing sector fell to a 21-month low.
The Standard & Poor’s 500 closed down 1.90%, but managed to cling to the 2800 level at 2800.71. The Dow Jones Industrial ended the day down 1.77%. The technology heavy NASDQ Composite declined 2.50%. And the Russell 2000 small cap index, with its heavy weighting in regional and small banks finished off 3.62%.