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Financial markets are not the economy and the economy is not financial markets. But it’s often said that they’re both afraid of the same things. In this case, the concern is that the economy is careening toward a recession.
“The alarm bells are telling us that something is going to break somewhere in the financial system,” said Karl Schamotta, chief market strategist at Corpay, a foreign exchange service in Toronto.
Stock markets have sold off over the past three months. Since the beginning of July, the TSX wiped out all of the gains it made in the first half of the year.
U.S. stock indexes, such as the S&P 500 and the Dow Jones Industrial Average, have remained in positive territory, but not by much.
Those markets reflect a doomy prognosis that isn’t necessarily backed up by the economic data.
GDP and jobs numbers have shown a surprising resilience. The most recent figures indicate that the economy was flat in July, while a preliminary estimate shows it expanded again in August.
Canadian employers added 64,000 jobs in September.
That’s a far cry from the forecast of a recession through the third quarter of this year.
But Schamotta says that surprising resilience doesn’t negate the fact that Canadian households and businesses are in the midst of the most aggressive cycle of interest rate hikes this country has ever seen.
“We know historically when borrowing costs have risen this much that that stresses some part of the financial system — and as Warren Buffett likes to put it, when the tide goes out, suddenly we see who’s swimming naked,” he told CBC News.
Why the bond market matters
Stock markets are a notoriously volatile, fickle way of guessing where the economy is headed. The bond market is much bigger and far less whimsical.
And this week the bond market started flashing red.
Stock markets, where investors buy ownership slices of companies, get all of the attention, but the bond market — where companies and governments go to borrow billions of dollars each and every day — is a much more fascinating gauge for smart prognosticators like Schamotta.
Investors have been selling older bonds in exchange for newer ones that pay more. That bond sell-off has driven down the price of those bonds, but the yield — the percentage return that you’d get from holding them — has moved sharply higher.
On Friday, the yields on 10-year Treasury bills in the United States surged more than 15 basis points to 4.89 per cent. The five year Canadian government bond saw its yield jump 20 basis points to 4.42 per cent.
David Rosenberg, founder and president of Toronto-based Rosenberg Research, says U.S. Treasuries with maturities of 10 years or more have plunged 46 per cent in value since 2020 — all while disposable incomes (when adjusted for inflation) have fallen into negative territory.
Featured VideoAbout one in five variable rate mortgage holders at three major banks are now in ‘negative amortization’ — where the time it takes to pay off the home loan is getting longer. It’s causing concern with regulators who plan to reign in the type of loan that allows it. One man saw his repayment period go from 25 to 47 years.
“These are crazy times, my friends,” Rosenberg wrote in a note to clients. “Real disposable incomes are down three months in a row.” And they’re on pace to fall by 1.7 per cent this year.
“The only reason spending has yet to follow suit is because of prior fiscal stimulus which has ended, and the boom in credit card usage.”
The bond market matters in all of this because it sets the price of money. And as everyone knows, Canadians took on a ton of debt over the past decade.
Schamotta says if you combine household, corporate and government debt in Canada, it is now more than four times the size of our entire economy.
“That’s far beyond anything we had reached before,” he said. “But it’s also among the highest debt loads in the world. We are not the prudent Canadians that the world thinks we are.”
The problem, of course, is that much of that debt was taken on at record-low interest levels.
Economy sending ‘mixed signals’
Spiking bond yields means investors are starting to think that high interest rates are going to stick around a lot longer than was previously thought, and they’re demanding to be paid more for the risk of lending out their money.
Still, some economists say it’s important to differentiate between financial markets and actual economic data.
“It looks like the economy still has quite a lot of steam to get us through this period without falling off a cliff and getting into a recession,” said Tu Nguyen, an economist in Toronto with the accounting and consultancy firm RSM Canada.
She is now forecasting that the Canadian economy will stick a sort of “soft landing.”
A soft landing is a scenario in which gross domestic product and job growth slow enough to tame inflation without forcing the economy to slip into a recession. It would be a remarkable needle to thread after years of the COVID-19 economic catastrophe, soaring inflation and rising interest rates.
Nguyen admits that the economy has been rife with contradictions.
“It is a little confusing because it seems like we’re seeing mixed signals, and I think we’ll continue to see that,” she told CBC News.
But she maintains that the “real economy” (GDP, jobs and inflation numbers) are increasingly painting a healthier picture than expected, and she says that’s a better reflection of what’s going on in the economy than markets betting they know what’s going to happen next.
But if the economy has had one characteristic over these past years, it’s been the ability to surprise everyone.
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