Stocks fall as bond market flashes a recession warning

The bond market smells a recession. On Friday, stock investors caught a whiff, too.

Economic forecasters and Wall Street traders have been watching for months as interest on long-term U.S. government bonds has dropped toward the rates on short-term debt.

Investors normally demand higher yields to buy longer-term bonds, and when those long-term yields decline it can signal a slowdown in economic growth.

On rare occasions, long-term yields can actually fall below yields on short-term bonds — a “yield curve inversion” in the parlance of the markets. Such unusual occurrences have preceded every recession over the past 60 years.

And it happened Friday.

The inversion followed a sharp decline on yields on long-term Treasury bonds this week after the Federal Reserve decided Wednesday to leave interest rates unchanged and signaled that it was unlikely to raise rates through the end of 2019.

But a round of dour economic data from Europe actually pushed the measure into inverted territory. The yield on the 10-year Treasury note tumbled to 2.45 percent early Friday, its lowest level since January 2018. That was just below the 2.46 percent yield on three-month Treasury bills.

There are many ways to measure the yield curve. On Wall Street, many analysts look at the difference between yields on two-year and 10-year Treasury notes, which has not yet inverted.

But research from the Federal Reserve Bank of San Francisco has cited the yield difference between three-month Treasury bills and 10-year Treasury notes — which inverted Friday — as the most reliable predictor of recession risk.

Traders in the stock market picked up on the downbeat signal. The S&P 500 had been climbing despite a recent drop in bond yields, effectively shrugging off the decline as further evidence...