Market Insights | February 2026
Energy Shock and Recession Dynamics:
Reinforcing the Case for Canadian Long Bonds
Key Takeaways:
- Energy Shock Weighs on Growth: Rising energy prices act as a tax on consumers, reducing discretionary spending and accelerating demand destruction.
- Stagflation Signals Emerging: PMIs reflect slowing activity alongside rising price pressures, pointing to a stagflationary backdrop.
- Short-Term Yield Spike Likely Temporary: Recent increases in front-end yields reflect inflation fears, but weakening growth should pull long yields lower.
- Canada Entering Recession: Weak Gross Domestic Product (GDP) and deteriorating labour data confirm a broad-based economic slowdown.
- Long Bond Opportunity Strengthens: A recession-driven bull flattening sets up significant capital appreciation potential in Canadian long-duration bonds.
Macro Backdrop: Energy Shock and Growth Impact
The escalation of conflict in the Middle East has driven energy prices sharply higher, triggering renewed inflation concerns and a rise in short-term government bond yields in both Canada and the United States. Longer-dated yields have also moved higher, though to a lesser extent.
Higher energy prices function as a regressive tax, compressing household purchasing power and reducing discretionary consumption. The longer the disruption persists, the greater the cumulative impact on demand, ultimately translating into slower economic growth.
Purchasing manager indices reflect this shift. Recent surveys show declining activity levels alongside rising price components—early evidence of a stagflationary environment characterized by weakening growth and persistent inflation pressures.
Supply Chain Risk: Strait of Hormuz
The Strait of Hormuz represents a critical chokepoint for global trade. Prolonged disruption would have lasting economic consequences, even after reopening.
Production constraints emerge quickly when transport routes are blocked, as storage capacity fills and output must be curtailed. Restarting production is time-intensive, meaning even short-term closures can result in multi-month supply disruptions.
Beyond crude oil and LNG, each representing roughly 20% of global supply flows through the Strait, the route is also essential for agricultural inputs, including nitrogen and sulfur-based products. Disruptions during planting season could materially impact global crop yields, adding another layer of inflationary pressure and potential economic strain.
Bond Market Dynamics: Bear Flattening to Bull Flattening
The recent rise in yields reflects a bear flattening dynamic, short-term rates moving higher on inflation concerns, with longer-term yields following to a lesser degree.
This reaction is likely temporary. As growth data weakens, the market is expected to transition toward bull flattening, with long-term yields declining as investors price in slower economic activity and eventual monetary easing.
Oil Market Signals: Temporary Spike, Structural Oversupply
Futures pricing for West Texas Intermediate (WTI) crude suggests that current price increases are not expected to persist. The forward curve remains in backwardation, with contracts for late 2026 and 2027 priced significantly below current levels.
This reflects an underlying market view that supply remains ample and that demand destruction will ultimately outweigh near-term disruptions. Prior to the conflict, crude prices had been trending downward within a multi-year channel, reinforcing the expectation that prices will normalize once supply constraints ease.
Chart: Crude Oil (WTI – West Texas Intermediate) Front Contract. 4-Year Weekly
Source: Bloomberg
Canada: Weak Data Confirms Downturn
Recent Canadian economic data confirms a deteriorating backdrop. Following a contraction in Q4 real GDP, the February employment report showed a sharp decline of 83,900 jobs, driven primarily by a significant drop in full-time employment.
The rise in unemployment and the composition of job losses point to underlying weakness rather than temporary volatility. The data suggests that Canada is either entering or already in a recessionary environment.
Chart: Canada February Employment Change by Industry
Source: Statistics Canada
Outlook and Implications
The inflationary impulse from higher energy prices is likely to be temporary, while the negative impact on growth is more persistent. As purchasing power erodes and uncertainty rises, demand destruction is expected to broaden across the economy.
This dynamic supports a decline in long-term bond yields as markets increasingly price in weaker growth and eventual policy easing. Divergence within the U.S. economy, where AI-driven capital expenditure remains strong while broader activity moderates, further reinforces this outlook.
Canadian long bonds are positioned to outperform, supported by weaker domestic fundamentals and a more advanced stage in the economic slowdown.
Canadian Long Bonds: Asymmetric Return Profile
In recessionary environments, long-term yields typically decline sharply as investors move to lock in higher yields ahead of central bank easing. This results in bull flattening, where long yields converge toward declining short-term rates.
Current market conditions:
If the Bank of Canada reduces its policy rate toward 2.00%, the 30-year yield could decline toward 2.25%, a move of approximately 175 basis points. A full curve flattening scenario could see yields approach 2.00%, implying substantial capital gains.
Market pricing continues to underestimate the depth of the economic slowdown, creating a compelling opportunity in Canadian long-duration government bonds.
CHART : Government of Canada 30-year yield (brown LHS) vs 2-year yield (green RHS)
Source: Thomson Reuters
The commentaries contained herein are provided as a general source of information based on information available as of February 28, 2026 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication however, accuracy cannot be guaranteed. Market conditions may change and Caldwell Investment Management Ltd. accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
Published on April 6, 2026