U.S. stocks on Tuesday are in free fall, just a day after equity benchmarks mounted a rally that took the Dow Jones Industrial Average to its best close in a month, following a trade-tension moratorium between the U.S. and China.
closed Tuesday down almost 800 points, or 3.1%, with the financial sector for the S&P 500 index
registering its worst daily slump since Feb. 8.
So, why has investor sentiment done a complete 180-degree turn from Monday’s euphoria?
At least part of the downturn come amid an ominous narrowing in the spread between U.S. 10-year Treasury note
and two-year Treasury note yield
to the tightest gap, about 10 basis points, in about 11 years.
The rate spread between the 2-year and 10-year government — at around 10 basis points, or 0.10 percentage point, at its tightest — is closely followed because a narrowing gap indicates a dim outlook for the economy. A so-called yield-curve inversion, where the yield on shorter-dated debt rises above that of longer-dated bonds, has been a feature that has preceded every recession since 1975.
Although the two-year and the 10-year haven’t inverted yet, the skinnier differential between the pair as well as an inversion of the two-year-to-5-year
section of the yield curve has market participants on edge.
Inversions are perceived as a negative for Wall Street because it undercuts the business models of banks, the engine of most financial markets, which lend on a short-term basis and lend over a longer term.
Expected rate increases by the Federal Reserve, one as soon as later this month, and waning enthusiasm about a murky detente in tariff disputes between Beijing and Washington also have combined to stoke investor anxieties, driving more robust appetite for longer-dated bonds compared against their shorter-dated counterparts.
On Tuesday, Jeff Gundlach, the chief executive of DoubleLine Capital, told Reuters that he believes the inversion of short-dated debt suggests that the “economy is poised to weaken.”
Jeffrey Gundlach, ceo of doubleline capital, says yield curve inversion on short end signaling that ‘economy is poised to weaken’ @Reuters
— Jennifer Ablan (@jennablan) December 4, 2018
He also said the Fed must be “especially careful in its choices of words” when it meets later this month to deliver on a promised rate hike. The rate-setting Federal Open Market Committee is slated to meet Dec. 18-19 for its final policy gathering of 2018.
“While US growth is still holding up OK, worries are increasing about the overseas economic outlook. All this macro-economic uncertainty is clouding the 2019 earnings outlook, leading to increasingly violent equity swings as investors try to handicap what 2019 will look like, wrote Alec Young, managing director of global markets research at FTSE Russell, in a Tuesday note email message.
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