Canada's main stock index, the S&P/TSX Composite, slipped 0.67% on Tuesday as a key US bond yield crossed a psychological threshold and traders grew more convinced that the Federal Reserve will raise interest rates again. The move came even as energy stocks, a heavyweight on the TSX, managed to hold their ground thanks to persistently high oil prices.
The trigger for the selloff was the US 10-year Treasury yield climbing above 5% for the first time in over a decade. That matters because the 10-year yield is often seen as the "risk-free" return that investors can earn from government bonds. When that number goes up, stocks have to offer a higher potential return to justify the extra risk. With the risk-free rate now above 5%, many investors are asking whether equities are worth the gamble.
Fed hike odds jump
Adding to the pressure, traders are now pricing in a more than 90% chance that the Federal Reserve will raise its benchmark interest rate at its next meeting, according to CME Group's FedWatch tool. That tool tracks futures market data to estimate the probability of Fed moves. A hike would mark another step in the central bank's fight against inflation, but it also means borrowing costs for businesses and consumers would stay elevated for longer.
The combination of higher yields and the prospect of more rate hikes tends to hit the most rate-sensitive parts of the market hardest. Sectors like technology, real estate, and utilities, which rely on borrowing to grow and often pay dividends that look less attractive when bonds pay more, are typically the first to feel the squeeze. On the TSX, those sectors likely dragged the index lower, even as energy stocks provided some support.
Oil stays high, energy holds up
Oil prices remained elevated, with benchmarks hovering above $107 a barrel. That's been a key support for Canada's energy-heavy index. Energy companies, which make up a large portion of the TSX, benefit directly from higher crude prices, and their shares have been resilient even as the broader market wobbles. The strength in energy helped cushion the index's decline, but it wasn't enough to offset the broader risk-off mood.
The high oil price is also feeding into inflation concerns. When energy costs rise, they push up the price of everything from gasoline to heating bills, which can keep inflation sticky. That's one reason bond yields are climbing and the Fed is expected to keep tightening. It's a feedback loop that investors are watching closely.
What it means for investors
For everyday investors, the key takeaway is that the era of cheap money is firmly in the rearview mirror. When the 10-year yield is above 5%, the bar for stock market returns is higher. Investors may want to think about how their portfolios are positioned in this environment. Diversification, including a mix of assets that can perform differently under various conditions, becomes more important.
Energy stocks, for example, have been a bright spot, but they're also volatile and tied to global supply and demand. Meanwhile, bonds, which many investors use for stability, are now offering more income than they have in years, but their prices fall when yields rise. That means even a "safe" bond portfolio can lose value in the short term.
The broader market backdrop is also worth noting. European stocks slipped and Asian markets were soft as the same forces—high oil and rising yields—pressured risk assets globally. The US dollar has also been firm, which can weigh on commodities priced in dollars and on emerging markets.
For Canadian investors, the TSX's energy exposure is a double-edged sword. It provides a buffer when oil is strong, but it also means the index is more sensitive to swings in crude prices. If oil were to fall sharply, the TSX could face steeper losses than other markets.
Looking ahead, all eyes will be on the Fed's next decision. If the central bank does hike, as traders expect, the question will be whether it signals an end to the tightening cycle or leaves the door open for more. That will likely determine whether yields keep climbing and whether stocks can find their footing.
In the meantime, the message from the market is clear: higher yields and higher oil are a potent mix that investors are still trying to digest. For those with a long-term horizon, periods like this can be unsettling, but they also underscore the importance of staying disciplined and not making impulsive moves based on short-term swings.
