NEW YORK — Wall Street hoisted another hurricane warning on the economy on Wednesday as fear continues to rise that a recession could arrive by next year, potentially crashing into President Donald Trump’s attempt to win a second term.
This time, the warning came from the bond market where investors began to demand more interest on two-year Treasury debt than 10-year debt, an “inversion” of a measure known as the yield curve that last happened in 2007 before the financial crisis. The fresh scare helped drive the Dow Jones Industrial Average down 800 points, or three percent, and spurred Trump to cast blame on the U.S. Federal Reserve in a series of afternoon tweets.
It sounds like a wonky bit of financial arcana. But it’s a closely watched gauge. And it has investors freaked out.
An inversion in this corner of the bond market has occurred before every recession since the 1950s, raising the potential for the 2020 election to look more like 2008 when a cratering economy dominated the political debate. That could derail Trump’s plans to make 2020 more like 1984 when Ronald Reagan ran a “Morning in America” campaign based on faster growth.
“You have a little bit of panic going on here about the state of the economy and the bond market is reflecting that,” said Richard Bernstein, founder of investment firm RBAdvisors. “The bond market is telling you that growth is slowing and the economy may be a lot sicker than people believe.”
Stocks resumed their downward slide following the bond market inversion, with investors wiping out gains that came when Trump announced a reprieve from many of the tariffs he planned to slap on consumer goods imported from China including cellphones and laptop computers on Sept. 1.
Trump on Tuesday delayed most of the tariffs until Dec. 15, saying he didn’t want to risk higher prices during the Christmas shopping season. This appeared to undermine his argument that the Chinese are paying for all of the tariffs rather than American businesses and consumers.
In addition to the bond market inversion, investors on Wednesday reacted to slower growth in China and Germany. They also took note of anonymous administration officials quoted in media reports suggesting the pause in the trade war — which followed a telephone call between U.S. and Chinese officials — did not signal any warming between the two sides. With Wednesday‘s tumble in the Dow, the blue chip index remains at a lower point than where it was 18 months ago, when the trade battle with China began in earnest.
Trump on Wednesday once again blamed the Fed, taking to Twitter the bash the central bank for not slashing rates fast enough.
“We are winning, big time, against China. Companies & jobs are fleeing. Prices to us have not gone up, and in some cases, have come down. China is not our problem, though Hong Kong is not helping. Our problem is with the Fed. Raised too much & too fast. Now too slow to cut," Trump tweeted. “Spread is way too much as other countries say THANK YOU to clueless Jay Powell and the Federal Reserve. Germany, and many others, are playing the game! CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win!“
The recession warnings across Wall Street, which began to intensify over the weekend, cite multiple factors pulling on an economy that had already lost momentum this year as the impact from Trump’s 2017 tax cut began to fade. Growth slowed to 2.1 percent in the second quarter and most forecasts are now for further softening the rest of the year. The federal budget deficit is expected to soar over $1 trillion this year, limiting the ability of Washington to pump more stimulus into the economy through higher federal spending.
But the biggest drag cited by economists is uncertainty over trade, which is showing up in lower spending by businesses. The loss of the Chinese market is also hammering farmers.
The Fed, under relentless assault from Trump, reversed course last month and cut interest rates after a series of hikes intended to get policy closer to normal following a decade of rates close to zero in the wake of the financial crisis. The Fed is expected to cut rates at least once more this year and will be under added pressure following the latest yield curve inversion and stock market rout.
Economists also suggest that fear of recession, now coursing through the bond market, could itself make recession more likely. Consumer spending, job growth and wages remain healthy but once fear takes hold it can be a powerful driver to depress economic activity, making both businesses and individuals hold off on major investments.
“On the economics dashboard of doom, we have another flashing warning light,” economists at ING wrote in a note on Wednesday. “Overnight we have seen the inversion of the 2-10 year part of the Treasury yield curve, the first time this has happened since 2007 when the global financial crisis started to bite.”
Trump administration officials strongly reject the notion that the U.S. is heading for a recession. They say that continued strong jobs and wage growth will overcome any slowdown caused by uncertainty over trade. And they continue to maintain that Trump is working hard to overcome long-standing cheating by China on trade.
“There is no recession coming,” a senior White House official said on Wednesday. “The consumer is way too strong as are jobs and wages. I just don’t buy it.”
Some economists also argue that the inverted yield curve may not mean recession is coming this time. “This time is different” advocates argue that lower long-term bond yields in the U.S. — which usually signal that investors believe domestic economic conditions are going to get worse — are actually part of a global phenomenon. They note that yields are down around the world as central banks move to cut interest rates to try to stimulate growth. This may not suggest that the U.S. economy is about to stall out. And they warn against economic doom-saying becoming a self-fulfilling prophecy.
“The problem with using the inversion and the historical record is that the yield curve at present is not a referendum on the path of economic growth in the United States, but rather a function of goings on globally,” economists at RBC Capital Markets wrote in a note to clients. “We are not on recession watch because of this dynamic.”
But a more widely held view is that the inverted yield curve, while perhaps not a signal of imminent recession, is certainly not a positive signal.
“Of course it matters,” said Bernstein. “Whether recession starts in two weeks, or six weeks, or two years — or if we are already in one — it’s hard to see how one could become more bullish with an inverted yield curve.”
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