A global bond market selloff has significant implications for Canadian households and investors. Financial markets are readjusting their long-term expectations for interest rates, and this has led to a surge in bond markets around the world. Yields on the benchmark 10-year U.S. Treasury bond have hit a 16-year high, while the S&P 500 has reached its lowest level in four months.
This trend is also evident in Canada, with the TSX struggling and 16-year highs on bonds like the five-year Government of Canada yield. The stock market has been affected by soaring Treasury yields, as high yields divert investment away from stocks and towards bonds. Additionally, high yields make borrowing more expensive, which impacts corporate profits.
Bond yields play a crucial role in determining borrowing rates for Canadians, including mortgages and car loans. They have an indirect relationship with the Bank of Canada’s benchmark interest rate and can rise or fall based on the central bank’s actions or signals for future policy directions.
Senior economist at BMO, Robert Kavcic, suggests that bond yields are reaching decade-highs because financial markets believe central bank policy rates will remain higher for longer. Although annual inflation has cooled, it remains double the Bank of Canada’s target of two percent. This persistence of inflationary pressures has led global financial markets to lower their expectations for future interest rate cuts.
The U.S. Federal Reserve has already raised its main interest rate to the highest level since 2001 and indicated that rates may stay higher next year. While the Bank of Canada’s future rate decisions depend on data, they have not hinted at rate cuts in their latest decision. Kavcic believes that with bond yields rising, the central bank may not need to hike rates further as the market itself pushes up borrowing costs.
The flattening of Canada’s GDP growth in recent months has raised concerns about a recession. Bond markets have also indicated a recession through an inverted yield curve, where short-term bond yields outperform longer-term yields. This inversion suggests a slowing economy and potential interest rate cuts. However, Kavcic is confident in interpreting an inverted yield curve as a recession indicator, as it has never given a false positive before.
With the likelihood of higher interest rates becoming the “new normal” in global financial markets, stocks are also being affected. Companies will need to revise their capitalizations and growth expectations in an environment of restrained consumer spending power and limited corporate spending power due to tighter borrowing conditions. This will result in lower valuations.
Rebalancing portfolios with a healthier mix of stocks and bonds is advisable during this time. Opportunities in corporate bonds are emerging, presenting investors with higher yields not seen in over a decade. A 60-40 split of stocks to bonds is deemed appropriate for many investors, as it allows exposure to the bond market’s current opportunities.
In conclusion, the selloff in global bond markets has major implications for Canadian households and investors. The surge in bond yields, along with the potential for higher interest rates and a looming recession, is causing uncertainty in the stock market. Rebalancing portfolios with a mix of stocks and bonds is recommended during this time of market volatility.
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