Alarm bells are ringing: What markets are trying to warn us about the

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.

WATCH | Interest rates extended his variable-rate mortgage from 25 to 47 years:

Interest rates pushed his mortgage from 25 to 47 years

Featured VideoAbout one in five variable…

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