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* Flattening U.S. yield curve sparks economy worries
* Financials, industrials lead declines on S&P 500
* Small-cap Russell 2000 posts biggest drop in 7 years
* NY Fed official comments also rattle
* Indexes down: Dow 3.1 pct, S&P 500 3.24 pct, Nasdaq 3.8 pct (Updates with close of U.S. trading)
By Lewis Krauskopf
Dec 4 (Reuters) - Wall Street tumbled more than 3 percent on Tuesday, led lower by bank and industrial shares, as the U.S. bond market sent unsettling signs about economic growth and investors worried anew about global trade.
A prominent Federal Reserve official’s comments about the path of interest rate hikes added to the uncertainty for investors, as did setbacks for Britain’s plans to leave the European Union.
The S&P 500 posted its biggest single-day percentage drop in about two months, giving back some gains from Monday and a week earlier, when the benchmark index tallied its largest weekly percentage gain in nearly seven years.
The small-cap Russell 2000 dropped 4.4 percent, its biggest one-day plunge in more than seven years.
Investors were focused on U.S. Treasury yields, where the benchmark 10-year yield fell to its lowest point since mid-September. The spread between the 10-year yield over its two-year counterpart also shrank to the smallest in over a decade, a closely watched signal because a so-called yield curve “inversion,” when the two-year yields more than the 10-year bond, preceded all the recessions of the past 50 years.
Part of the curve did invert, with two-year and three-year yields holding above the five-year yield for a second day.
“It’s fears about the inverted yield curve and what that means for the economy and is it a precursor to a recession,” said Chuck Carlson, chief executive officer at Horizon Investment Services in Hammond, Indiana.
The Dow Jones Industrial Average fell 799.36 points, or 3.1 percent, to 25,027.07, the S&P 500 lost 90.31 points, or 3.24 percent, to 2,700.06 and the Nasdaq Composite dropped 283.09 points, or 3.8 percent, to 7,158.43.
The New York Stock Exchange and Nasdaq will be closed on Wednesday, for a day of mourning for former President George H.W. Bush, who died on Friday at the age of 94.
Stocks had rallied on Monday following a truce between U.S. President Donald Trump and Chinese President Xi Jinping on their trade dispute following weekend talks in Argentina, but investor optimism over a resolution faded on Tuesday. Trump himself warned he would revert to tariffs if the two sides could not resolve their differences.
“The sell-off that we have seen throughout the day is really about taking a look at the tariff conversation and realizing that nothing has been resolved and that there is still some work to do and some of the euphoria that we felt yesterday was more on the headline than on the substance,” said Delores Rubin, senior equities trader at Deutsche Bank Wealth Management in New York.
Financial shares, which are particularly sensitive to bond market swings, dropped 4.4 percent.
The trade-sensitive industrial sector fell 4.4 percent, with Boeing and Caterpillar declining 4.9 percent and 6.9 percent, respectively.
The Dow Jones Transport Average declined 4.4 percent, its biggest one-day percentage drop since June 2016.
Defensive Utilities eked out a 0.2 percent gain, the only one of the 11 major S&P 500 sectors in positive territory.
In comments on Tuesday, New York Fed President John Williams said the U.S. central bank should expect to continue raising interest rates “over the next year or so” even while it pays close attention to possible risks highlighted by financial markets.
The comments came after those from Fed chair Jerome Powell last week, which lifted stocks as they were interpreted as suggesting a less aggressive path of rate hikes.
“Maybe we’re not going to get as dovish a Fed as some think,” said Joseph LaVorgna, chief economist, Americas at Natixis in New York.
Declining issues outnumbered advancing ones on the NYSE by a 4.24-to-1 ratio; on Nasdaq, a 5.96-to-1 ratio favored decliners.
The S&P 500 posted 40 new 52-week highs and 29 new lows; the Nasdaq Composite recorded 36 new highs and 220 new lows.
About 9 billion shares changed hands in U.S. exchanges, above the 7.7 billion-share daily average over the last 20 sessions.
Additional reporting by Richard Leong and Herbert Lash in New York, Shreyashi Sanyal in Bengaluru; Editing by Shounak Dasgupta, Nick Zieminski and Jonathan Oatis