Last week, we argued that the risk rally was running on borrowed time. That still looks right. What has changed is the source of the pressure.
Equity investors have largely looked through the conflict in the Middle East. The market has been resilient, supported by renewed enthusiasm around AI and a belief that the economic damage from higher energy prices will remain manageable.
Bond markets are sending a different signal.
Long term yields have moved back toward their highest levels since the war began, even as equities have held up. That divergence matters. Equities are still behaving as though the shock will prove temporary. Bonds are increasingly pricing the risk that it will not.
The rally has not broken. But the cost of sustaining it has gone up.
Oil is Still Setting the Terms
The core issue remains the Strait of Hormuz.
The market’s baseline assumption has been that the energy disruption would be temporary, that central banks could look through the immediate inflation impact, and that growth would slow only modestly. That remains possible. It is also becoming a more conditional view.
Oil prices are no longer just a geopolitical headline. They are feeding into rate expectations, bond yields, inflation expectations and central bank communication. Since the U.S. Iran conflict began, the correlation between Brent crude and 10-year government bond yields in major economies has become exceptionally strong. Bond markets are now taking their direction from energy prices more than from central bank reassurance.
That is the clearest sign that markets are moving from “look through the shock” to “price the transmission path.”
This does not make the adverse scenario inevitable. But it does mean the baseline is less comfortable than it was a week ago. If the Strait reopens and energy markets start to normalize, yields can still move lower and risk assets can continue to find support. If energy prices remain elevated, the pressure will not stay isolated in commodities.
It will move through inflation expectations, central bank reaction functions, consumer spending, corporate margins and earnings expectations.
Markets are not fully pricing that yet. But they are starting to move in that direction.
Central Banks Bought Time, but They did not Remove the Risk
The major central banks did what markets needed them to do. They held rates steady, avoided overreacting to the immediate energy shock and signalled that they are prepared to respond if higher energy prices become embedded in inflation expectations.
That helped stabilize markets. It did not solve the problem.
The Fed left rates unchanged and maintained an easing bias, but the communication was more hawkish than in March. The dissent from regional Fed presidents against retaining that easing bias is important. It shows a growing split inside the Fed, with some officials more concerned about upside inflation risk as WTI moved back above $100 per barrel.
The Bank of Canada also left rates unchanged, but the tone shifted. The Bank revised growth higher, acknowledged that near term inflation expectations had moved up, and warned that sustained elevated oil prices could create a need for consecutive rate increases. That is not a small change. Canada is a net oil exporter, but the benefit from higher oil prices is not clean. Limited pipeline capacity may constrain the production response, while higher gasoline prices still pressure households.
The Bank of England held rates at 3.75%, but its scenario analysis was telling. If energy prices fall back, rates may stay on hold. If energy prices remain high and second round inflation effects develop, rate hikes become more likely. In the Bank’s more adverse scenario, policy could require a forceful tightening.
The European Central Bank also held rates steady but acknowledged that upside risks to inflation and downside risks to growth had intensified. Shorter term inflation expectations have moved up significantly, and markets are now pricing a greater probability of rate hikes.
The message is broadly the same across central banks. They do not want to hike into a growth shock. But they also cannot ignore inflation expectations if oil stays elevated. That is why the rally is more fragile than the equity market alone suggests. Policy has not turned restrictive again, but the option value of future easing has been reduced.
Canada’s Oil Benefit Comes with Complications
For Canada, the data are more mixed than the simple “higher oil is good for Canada” narrative suggests.
Growth has improved. February GDP rose 0.2% month over month (1), and first quarter growth appears to have rebounded to roughly 1.5% annualized. That gives the Bank of Canada more room to consider hikes if inflation risks continue to rise (2).
But the details matter.
Oil and gas extraction rose in February, but the March advance estimate suggested the sector may have become a drag despite higher oil prices. That points to a key constraint. Higher prices do not automatically translate into higher output if infrastructure limits the ability to respond.
The fiscal picture has also improved, helped by stronger nominal growth, higher oil prices and stronger equity markets. The Spring Economic Statement (3) revised last year’s deficit lower by $11 billion, and the debt to GDP ratio was nudged down. But this was not a clean fiscal consolidation story. New spending commitments were sizeable, and the deficit is still expected to remain around or above 2% of GDP over the next couple of years.
The result is a Canadian economy with more nominal support, but also more inflation sensitivity. That is manageable if oil prices settle. It becomes more complicated if oil remains above $100 and the Bank of Canada loses patience.
In our portfolio positioning, we do not view Canada as a simple energy hedge. The Canadian market can benefit from resource exposure, but the macro transmission is more complicated. Higher oil prices can lift revenues and nominal growth, while also tightening financial conditions, pressuring households and putting rate hikes back on the table.
AI Can Still Support Markets, but it Cannot Carry Everything
The equity rally has also been supported by renewed enthusiasm around AI related investment.
Recent data suggest that the AI buildout remains intact. Information and communications technology investment remains strong, business investment intentions have improved, and stronger investment growth may help offset some of the drag from slower consumption. That remains an important support for U.S. growth and corporate earnings.
But market leadership is becoming more demanding.
The market is leaning heavily on AI related earnings and capital spending to justify elevated valuations. That is not irrational. The investment cycle remains powerful. But the hurdle is higher than it was six months ago. Investors need earnings growth, evidence that AI capital spending is generating returns, and enough free cash flow durability to offset concerns about the scale of investment.
This is where last week’s “borrowed time” argument still applies. AI enthusiasm can extend the rally. It can also narrow it. A market led by a small group of companies can look resilient until expectations become too concentrated.
The risk is not that AI suddenly stops mattering. The risk is that AI has to do too much work in a market where oil is lifting yields, central banks are becoming more cautious, and consumer sentiment is being pressured by higher gasoline prices.
The Market is Now About Transmission
The next phase is less about whether equities can keep rallying for a few more days. They can. Markets can stay resilient longer than the underlying macro picture suggests. The more important question is whether the energy shock remains contained.
If the Strait of Hormuz reopens and oil prices fall back, the conditions for a broader rally and lower bond yields would likely improve. If the blockade persists, markets may need to price a more difficult mix of higher inflation, cautious central banks and slower real consumption growth.
That is the transmission path we are watching.
Oil affects inflation expectations. Inflation expectations affect central banks. Central banks affect yields. Yields affect valuations. Valuations affect equity leadership. Equity leadership affects portfolio concentration risk.
Markets often look calm until those links tighten.
CLIML Portfolio Positioning
In our portfolios, we have not treated the recent rally as confirmation that the macro risk has passed. We continue to maintain diversified equity exposure, with an emphasis on quality, capital discipline and businesses with the ability to defend margins in a higher cost environment.
We continue to view U.S. equities as structurally important, particularly given the depth of AI related investment and the strength of large cap earnings leadership. At the same time, we remain mindful that the U.S. market is carrying more concentration risk than usual, both at the security level and through the dominance of a narrow set of return drivers.
Within fixed income, we continue to see value in its stabilizing role over a full cycle, but we are not ignoring the near-term risk that elevated oil prices keep yields higher for longer. Within our fixed income positioning, duration remains part of the risk management framework if growth risks rise, but the path is less straightforward when the inflation impulse is coming from energy and central banks are trying to preserve credibility.
We also continue to value diversifying strategies that are less dependent on a single market outcome. In our view, where equities are leaning on AI, bonds are being pulled around by oil, and central banks are balancing inflation against growth, portfolio resilience is less about asset class labels and more about the understanding the underlying drivers of risk.
That is where this rally still looks vulnerable.
The market has not lost confidence. But confidence is now being financed by a narrower set of assumptions: oil normalizes, central banks stay patient, AI earnings hold, and bond yields do not move much higher.
That may still happen. But the longer energy markets remain disrupted, the more expensive that borrowed time becomes.
Sincerely,
Corrado Tiralongo (he/him)
Vice President, Asset Allocation & Chief Investment Officer
Canada Life Investment Management Ltd.
1 Statistics Canada
2 Bank of Canada press release - April 29, 2026
The views expressed in this commentary are those of Canada Life Investment Management Ltd. as at the date of publication and are subject to change without notice. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice. Prospective investors should review the offering documents relating to any investment carefully before making an investment decision and should ask their financial security advisor for advice based on their specific circumstances.
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