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Why the inverted yield curve could send stocks below their Christmas Eve lows

Scott Gamm

Since when was the Federal Reserve’s dovish about-face bad for markets?

The recent policy shift, in which the Fed told the market it doesn’t expect to raise interest rates at all in 2019, led to a partial inversion of the yield curve, which commenced last Friday for the first time since 2007. The 3-month bill now yields more than the 10-year Treasury. An inverted yield curve historically precedes a recession.

“We think that the recent inversion of parts of the U.S. Treasury yield curve is a bad sign for the S&P 500, which we expect to fall sharply over the rest of this year as growth in the US economy disappoints,” wrote analysts from Capital Economics in a note to clients Tuesday.

The analysts note that in the past, with the exception of 1998, when the 10-year Treasury yields lower than other shorter-term bonds, the S&P 500 (^GSPC) declines within 18 months.

Adding to the downside market risks, the analysts don’t see the Federal Reserve cutting interest rates until it is crystal clear that the economy is in trouble. “We doubt rates will fall until 2020,” they wrote.

To sum up, Capital Economics isn’t expecting recession, but it is expecting slower U.S. and global growth.

Since S&P 500 companies derive almost half of their revenue from overseas, that doesn’t bode well for U.S. stocks.

“We forecast that the [S&P 500] will fall sharply, to 2,300, by the end of 2019,” the analysts wrote.

That would represent an 18.4% decline from where the index sits now, at just over 2,800. The 2,300 level is also just shy of its 2,351 close on Dec. 24, 2018, a day widely viewed as the recent stock market low.

Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.

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