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The stock market tumbled Friday when investors digested an unfortunate warning sign: The interest rate on long-term government debt fell below the rate of short-term bills. It is often a signal that a recession is on the horizon.
The Dow Jones Industrial Average fell more than 460 points Friday, or around 1.8 percent. The broader S & P 500 index fell 1.9 percent.
The yield on long-term debt is usually higher, just as a 10-year deposit tends to pay higher interest rates than 3-month CDs.
Farmer guards become nervous when the typical pattern is turned on.
"We don't see what's happening often, but when it does, it's almost always bad news," said Campbell Harvey, an economics professor at Duke University.
Therefore, the warning lights began to flash Friday morning as the return on 10-year government bond loans declined during the three-month bill. The last time that happened was just before the big recession.
Harvey has watched these rare "inverted" yield curves for more than 30 years and treats them as a kind of early warning signal.
"My indicator has successfully predicted four of the last four recessions," he said, "including a rather important conversation before the global financial crisis."
Harvey will not forecast a recession unless the yield curve is reversed for at least three months. But even a flat curve – where long-term returns are just over short-term returns – can be an indicator that the economy is losing steam.
"We may be avoiding a recession but economic growth will be lower – much lower," Harvey said.
On Wednesday, the Federal Reserve reduced its own economic growth forecast, to just over 2 percent for the year, indicating that it was unlikely to increase interest rates in 2019.
Fed chairman Jerome Powell said slowing growth in China and Europe presents "headwinds" to the US economy. "There is some uncertainty," Powell said.
Unemployment is low at 3.8 percent, but the economy added only 20,000 jobs in February, far less than expected by economists and the least win since September 2017.
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