TSX slumps to lowest level in more than a year as bond market flashes warning sign of recession

The Toronto Stock Exchange's main stock index has given up all of its gains for 2023, as investors head for the exits as the realization that high interest rates are going to stick around settles in.

The S&P/TSX Composite Index lost more than 264 points, or 1.9 per cent, on Monday, the latest in a recent string of losses in a stretch that has seen the benchmark lose more than seven per cent since the middle of September, and wiping out all of its gains since the start of the year in the process.

When markets opened on Tuesday, the TSX was down another 170 points in early trading, with just about every sector — from energy to banks to telecom, utilities, technology and health care — lower.

The benchmark Canadian stock index is one of many around the world caught up in a wave of selling that's been prompted by the prospect of a global economy showing signs of slowdown.

Oil prices, which have rallied from $79 US a barrel at the end of August to as high as $93 last week, have lost ground for four days in a row, as the price for West Texas Intermediate was below $89 on Tuesday. Lower prices for energy imply that investors think there will be less demand for it in a slowing economy.

Central banks around the world have raised interest rates aggressively in an attempt to bring down high inflation. While the strategy has for the most part worked to bring inflation back toward the two per cent target, there's a growing sense that central banks are quite content to keep interest rates where they are for a lot longer than previously thought.

Consumers have felt the pinch of high interest rates mostly in the mortgage market, where variable rate loans have skyrocketed. But businesses have felt it, too, as their cost of borrowing has gone up at a time when consumers are showing there's a limit to how many price increases they're willing to pay for goods and services.

It's a recipe for market watchers to start uttering the dreaded R word that tends to cause investors to head for the exits.

"We got GDP data last Friday that is supporting the fact that we are going into recession," said Jules

Boudreau, a senior economist at Mackenzie Investments. "I think it's pretty clear in Canada," he said.

Canada's economy contracted in the second quarter, and data next month may show it did the same in the third quarter, which would meet the technical definition of a recession.

Bonds warning of recession

Stock markets aren't the only thing flashing the red recessionary warning sign, either.

Bonds have sold off as investors move their money from older ones that pay little to new ones with higher coupons. That sell-off has pushed yields on government debt to its highest level in years.

The yield on a five-year Canadian government bond jumped 20 basis points to 4.42 per cent. That's its highest level since 2007. That implies investors think high interest rates are going to stick around for a while.

Under normal circumstances, yields on long-term debt should be higher than that on short-term debt, since investors demand a higher return in exchange for locking up their money for longer.

But the opposite is happening right now, as the yield on a two-year bond is higher than what you'd get for a a five-year, 10-year and even a 30-year bond. It's a phenomenon known as an inverted yield curve, and it has an uncanny track record of accurately predicting recessions.

"You've got bonds under a lot of pressure with the higher-for-longer trade coming in," Boudreau said. "Equity markets are down because of these higher bond yields."