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A signal of recession flashes for first time since 2007 -- and Dow drops 460 points

One of the most closely watched predictors for recession just sent an alarm signal, sending stock markets plummeting. An indicator that investment pros call the "yield curve" flipped on Friday for the first time since 2007 during the Great Recession. 

Stocks dropped in response. The wave of selling knocked 460 points off the Dow Jones Industrial Average, a near-1.8% loss for the day, and the benchmark S&P 500 index saw its biggest one-day drop, 1.9%, since Jan. 3.

Here's why the bond yields matter. Investors show how confident they are about the economy by how much interest they're demanding from U.S. government bonds. Typically, short-term debt yields less interest than long-term debt.

But on Friday, a Treasury bill maturing in three months yielded 2.45 percent, 0.03 percentage points more than a Treasury maturing in 10 years. That means investors believe the short-term market is riskier than the long-term market -- not a good message for other investors. The rule of thumb is that an inverted curve can signal a recession in about a year. Such a signal has preceded every recession in the last 60 years with only one false alarm, according to the San Francisco Fed.

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Economists warned against reading too much into the signal Friday, noting that the time between when the curve inverts and when a recession hits can be significant. As Gregory Daco, chief economist at Oxford Economics, explained in a note: "[T]he yield curve remains a key leading indicator of recessions, but lead times have historically been long – nearly two years on average since the 1980s – and variable – ranging from 10 months to three years. Further, short-lived inversions are more likely [in a low interest rate environment like today's]." 

The Federal Reserve expects the U.S. economy to expand at a moderate 2 percent this year.

-The Associated Press contributed reporting.

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