Stocks drop as falling United States yields, trade worries hit mood

The signal is called the "yield curve", and it shows how the bond market is feeling about the U.S. economy's long-term prospects.

-China trade talks. The inversion of a portion of the Treasury yield curve for the first time since 2007 reinforced the impression that markets are approaching the end of the current cycle.

Meanwhile, the flattening U.S. yield curve weighed on investors' minds.

A typical yield curve includes much higher interest rates for maturities further into the future.

Lyngen said the inversion of 3- and 5-year yields has increased the likelihood that an inversion of the 2- and 10-year yield will happen in late 2018 or early 2019. Sometimes, yield curves can become inverted, a scenario in which short-term yields are higher than long-term yields.

The difference between the two-year and the 10-year Treasury yields hasn't yet inverted, although it has flattened to 11 basis points-that is, 11 hundredths of a percent-from 25 basis points last Wednesday. Most economists are forecasting the USA economy will continue to grow in 2019, though at a slower pace than this year.

The dollar, which started the week on a weak footing as the apparent thaw in trade tensions between the USA and China cooled demand for the safe-haven currency, extended its fall as investors anxious about the inversion of the short end of the US yield curve in bond markets. Shanghai markets (.SSEC) fell 0.6 percent, their losses limited by Chinese officials expressing confidence that a trade deal would be clinched on time.

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However, investors are increasingly concerned by a flattening of the spread between 2-and 10-year Treasuries, a more fundamental benchmark of market health.

"This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that", Ian Lyngen, the head of united rates strategy at BMO Capital Markets, told CNBC.

An inversion of this part of the yield curve has preceded each of the last nine recessions dating back to 1955.

MSCI's broadest index of Asia-Pacific shares outside Japan edged down 0.2 percent as the Australian market gave up 0.5 percent and Seoul's Kospi fell 0.6 percent. Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

"The market decline in the US overnight and the flattening of the yield curve reflect that economic growth momentum is taking over as the primary concern for investors", Tai Hui, a strategist at J.P. Morgan Asset Management told clients.

European markets opened lower, with a pan-European index (.STOXX) down 1.2 percent. That is to say, almost everyone is convinced the two-year to 10-year if not the 3-month to 10-year spread will invert. Even if the more important parts of the yield curve flip to inversion, that doesn't mean a recession will happen the next day.

Typically, the yield curve slopes upwards over time, especially in times of strong economic growth. On Tuesday, the Dow Jones Industrial Average fell almost 800 points, or 3.1%, largely in response to recession fears stoked by recent changes in the yield curve.

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