(CNN) – The Dow slid more than 400 points Wednesday after the bond market, for the first time in over a decade, flashed a warning signal that has an eerily accurate track record for predicting recessions.
Here’s what happened: The 10-year Treasury bond yield fell near 1.6% Wednesday morning, dropping just below the yield of the 2-year Treasury bond. It marked the first time since 2007 that 10-year bond yields fell below 2-year yields.
US stocks fell as investors sold stock in companies and moved it into bonds. The Dow was about 1.5% lower. The broader S&P 500 was down 1.4% and the Nasdaq sank 1.6% Wednesday morning.
CNN Business’ Fear and Greed Index signaled investors were fearful. The VIX volatility index spiked 17%.
Investors are on edge because the German economy shrank in the second quarter, and the US-China trade war still looms large over markets, despite the latest truce. Industrial production in China grew at the weakest rate in 17 years.
As the global economy sputters, investors are plowing money into long-term US bonds. The 30-year Treasury yield fell to 2.05%, the lowest rate on record.
Government bonds — particularly US Treasuries — are classic “safe-haven” assets that investors like to hold in their portfolios when they’re nervous about the economy. Stocks, by contrast, are riskier assets that tend to be more volatile during economic slowdowns.
Here’s what this all means: Normally, long-term bonds pay out more than short-term bonds because investors demand to be paid more to tie up their money for a long time. But that key “yield curve” inverted on Wednesday. That means investors are nervous about the near-term prospects for the US economy. Bonds and yields trade in opposite directions, so yields sink when investors buy bonds.
Part of the yield curve has been inverted for several months. In March, the yield on the 3-month Treasury bill rose above the rate on the 10-year Treasury note for the first time since 2007. But Wednesday marked the first time in over a decade that the “main” yield curve — the 2-year / 10-year ratio — had inverted.
That spooked Wall Street, because an inversion of the 2/10 curve has preceded every recession in modern history. That doesn’t mean a recession is imminent, however: The Great Recession started two full years after the December 2005 yield-curve inversion.