One day, the record levels of Canadian household debt will form a big hurdle to overall economic growth and the residential real estate market. The higher interest rates expected in 2018, combined with the fact that almost half of existing domestic mortgages will renew in the next 12 months, increases the risk of a debt-focused slowdown next year.
Statistics Canada reported retail sales data for October on Thursday, and the results were healthy, indicating a 6.7-per-cent year-over-year increase. For now things look fine, but in 2018 investors should be watching consumption data in case they provide an early warning that consumer debt levels are limiting economic growth and that a deleveraging cycle is under way.
In a Dec. 4 report called "Household Debt: Implications for Financial Stability and Growth," Citi economist Paul Brennan writes: "The increase in debt servicing associated with high and rising household debt acts as a drag on consumer spending … [and] if asset prices fall and interest rates rise, these would add to the downward pressure on consumer spending."
The premise here is that financial pressures on indebted Canadians will first be visible in weaker-than-expected retail-spending growth – consumers who are (or feel) short on cash will spend less in the stores but still make their mortgage payments in full.
The first chart compares the year-over-year changes in both domestic home prices and retail spending for the past five years. From February, 2016, until July, 2017, growth in housing prices outstripped spending growth by a significant margin. After July, 2017, the rate of national home-price growth slowed to a still-healthy 9.2 per cent from 14.2 per cent. Retail sales growth slowed to 6.2 per cent from 7.6 per cent.
There isn't much for investors to react to yet in the chart. But investors should watch carefully for negative surprises in retail spending in 2018 as a leading indicator for weakness in housing prices and for Canadian businesses sensitive to gross domestic product growth.
The second chart compares national retail spending growth with the hottest housing markets of Vancouver and Toronto. House prices in both cities are still rising, but the pace of appreciation has slowed dramatically. I find it interesting that Vancouver's housing-price growth rate bottomed right near the national average for retail sales increases, but on the other hand there's no reason to expect that real estate prices in every city should track national consumption levels.
Retail sales will be one of the – if not the most important – economic data set for investors to follow in 2018. We are all accustomed to hearing that Canadian household debt levels have reached new record levels and, as Citi notes, there is no avoiding an eventual reckoning in the form of slower economic growth. Consumption data are likely to provide important clues as to the timing of this adjustment.