Skip to main content

North American stocks plunged on Tuesday as skepticism grew about a U.S.-China trade accord, and a closely watched recession indicator broke into ominous territory.

The U.S. yield curve, which measures the difference between shorter- and longer-term government bond yields, narrowed to its tightest point since before the financial crisis. The curve is important because short-term interest rates are nearly always lower than long-term rates. On the rare occasions when that pattern has inverted over the past 60 years in the United States, and it has cost governments more to borrow money for shorter periods than for longer ones, a recession has nearly always followed within a year or two.

Markets are now just a whisker away from receiving such a signal. The most widely followed version of the yield curve, which measures the gap between two- and 10-year U.S. government bond yields, dropped under 10 basis points at one point on Tuesday, its flattest level since June, 2007. (A basis point is one one-hundredth of a percentage point.)

Optimists can argue the curve is still a tiny step away from an outright inversion. However, investors were in no mood on Tuesday to quibble over a fraction of a percentage point. Most expect the U.S. Federal Reserve to boost short-term rates on Dec. 19, which would push that end of the curve even higher and increase the odds of an inversion. Many people took the flattening curve as a sign to sell.

In New York, companies that depend on international trade dragged on major indexes. The Dow Jones industrial average shed 799.36 points to 25,027.07, a 3.10-per-cent setback, while the S&P 500 surrendered 90.31 points, falling to 2,700.06, a 3.24-per-cent loss. U.S. markets will be closed on Wednesday in a national day of mourning for former U.S. president George H. W. Bush.

In Toronto, the S&P/TSX lost 211.39 points, falling to 15,063.59, a 1.38-per-cent decline.

The pervasive pessimism was a sharp contrast to the glee that reigned over markets on Monday after news that U.S. President Donald Trump and Chinese President Xi Jinping had agreed to a 90-day ceasefire in their trade skirmish. Doubts are now growing about the extent of the accord, as China has still to confirm some of the concessions claimed by the U.S. side.

Mr. Trump added to the worries by tweeting on Tuesday that “President Xi and I want this deal to happen, and it probably will. But if not remember … I am a Tariff Man.”

Elsewhere in the global trade drama, British Prime Minister Theresa May’s path to Brexit became even murkier as her government was found to be in contempt of Parliament for failing to make public the legal advice it had received on the proposed split from the European Union. Parliament also backed a proposal that would allow it to shape the next steps if the House of Commons rejects Ms. May’s proposed Brexit deal next week.

The possibility of yet more uncertainty about trade added to increasing doubts about the outlook for global growth. In recent weeks, many of those worries have been reflected in volatile stock prices and sliding oil prices, but the most precise gauge of the growing pessimism is the U.S. yield curve.

As investors grow more cautious about the outlook for growth, they take shelter in ultrasafe longer-term bonds. The influx of buyers raises the value of these bonds and drives down their yields. That helps compress the gap between short-term and long-term rates and raises the chance of an inversion.

A study from the Federal Reserve Bank of San Francisco earlier this year found that every U.S. recession in the past 60 years has been preceded by an inverted yield curve. However, the curve is not infallible. In the mid-1960s, an inverted yield curve was followed by an economic slowdown, but not an official recession.

Making matters even murkier is that there is no fixed period between an inverted yield curve and the start of a recession. The San Francisco Fed study found the lag ranged from six months to two years. For now, investors aren’t in a mood to take chances.

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe