Stocks plunged on Wednesday, giving back Tuesday's solid gains, after the U.S. bond market flashed a troubling signal about the U.S. economy.
The yield on the benchmark 10-year Treasury note on Wednesday broke below the 2-year rate, an odd bond market phenomenon that has been a reliable indicator for economic recessions. Investors, worried about the state of the economy, rushed to long-term safe haven assets, pushing the yield on the benchmark 30-year Treasury bond to a new record low on Wednesday.
Bank stocks led the declines as it gets tougher for the group to make a profit lending money in such an environment. Bank of America and Citigroup fell 3.8% and 4.5% respectively, while J.P. Morgan also dropped 3.4%. The SPDR S&P Regional Banking ETF is down 2.65%.
"The U.S. equity market is on borrowed time after the yield curve inverts," wrote Bank of America technical strategist Stephen Suttmeier.
There have been five inversions of the 2-year and 10-year yields since 1978 and all were precursors to a recession, but there is a significant lag, according to data from Credit Suisse. A recession occurred, on average, 22 months after the inversion, Credit Suisse shows. And the S&P 500 actually enjoyed average returns of 15% 18 months after an inversion before it eventually turns.
The last time this key part of the yield curve inverted was in December 2005, two years before the recession hit.
"Historically speaking the inversion of that benchmark yield curve measure means that we now must expect a recession anywhere from six-to-18 months from today which will drastically, and negatively, shift our medium-to-longer term outlook on the broader markets," Tom Essaye, founder of The Sevens Report, said in a note on Wednesday.
Shares of Macy's tanked nearly 17% after the retailer posted second-quarter earnings way below analysts' expectations as heavy markdowns used in spring to clear unsold merchandise weighed on profits.
Investors are increasingly worried about a global economic slowdown as weaker-than-expected data in China deepened the gloom in the world's second-largest economy. Official data published Wednesday showed growth of China's industrial output slowed to 4.8% in July from a year earlier, the weakest growth in 17 years.
Adding to the fears is Germany's GDP which shrank by 0.1% between April and June, fueling fears of a recession for Europe's largest economy. Euro zone GDP also grew by just 0.2% quarter-on-quarter, a significant slowdown from the 0.4% growth reported in the first three months of the year.
The U.S. decided to delay tariffs on certain Chinese goods while outright removing some items from the tariff list, the United States Trade Representative announced Tuesday. Wall Street cheered the news, with the Dow jumping as much as 529 points before settling to finish the day 372 points higher.
There are still seven "structural issues" the U.S. needs to settle with China through negotiations, White House trade advisor Peter Navarro told Fox Business Network on Wednesday. These issues include cyber intrusion into U.S. business networks, forced technology transfer, intellectual property theft and currency manipulation, he added.
China's Commerce Ministry said Vice Premier Liu He had spoken by phone with U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin on Tuesday and they agreed to talk again in two weeks.
— CNBC's Sam Meredith contributed reporting.