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Threat of Canadian financial crisis eases (but don’t take that to the bank)
Michael Babad

This article was published more than 6 years ago. Some information may no longer be current.

Briefing highlights

  • Risk of financial crisis eases
  • Canada-China trade talks uncertain
  • Markets at a glance
  • What to expect from BoC Wednesday
  • What to expect from U.S. jobs report
  • What else to watch for this week

Risks ease

The threat of a financial crisis in Canada is easing.

But don't take that to the bank. On two counts.

First, the risk hasn't been eliminated, only downgraded. And second, they may turn you down for a mortgage, anyway.

Certainly, the picture is improving. Canada has finally dipped below a key level on an early-warning indicator reported by the Bank for International Settlements, a body made up of the world's central banks.

That key level is 10, above which a country is considered at risk of huge strain on the banking system within three years. Known as the credit-to-GDP gap, Canada had been above that mark for some time, but had a better showing of 9.4 in the second quarter, the BIS said in its latest report, released Sunday.

The gap measures the ratio of debt to gross domestic product, compared to its long-term trend. So Sunday's measure means Canada is now 9.4 percentage points above the long-term average.

In measuring all credit to the non-financial sector, it takes in everything from loans to debt securities, and is aimed as a guide for the strength of capital buffers among commercial banks.

Over the past five years, the gap in Canada has run from a low of 6.9 in 2012 to a peak of 16.9 in the third quarter of last year, after which it began to decline.

So the threat has eased, but it hasn't gone away. Consider a BIS reading above 10 as flashing red, and anything between 2 and 10 as flashing yellow.

Not only that, Canada's 9.4 is still high among the countries measured.

Swollen household debt and fast-rising home prices have been a source of angst in Canada for quite some time, prompting federal and provincial governments, along with the commercial bank regulator, to bring in a series of measures. Consumers have also been leaning heavily on home equity lines of credit, or HELOCs.

The key measure of household debt to disposable income has been at or near record levels as Canadians borrowed ever more to pay those high prices, with growth in credit outstripping that of incomes. It stands now at 167.8 per cent, which means Canadians owe $1.68 for each dollar they have to spend.

The Bank of Canada warned again just last week that this is a major threat to the financial system, though it expects the problem to ease along with the new measures. One of those measures, for example, will make it more difficult to qualify for a mortgage.

Another part of the BIS report puts Canada in a noteable category for household debt alone. This includes countries whose household debt as a percentage of GDP is "high and rising" since the 2008 global meltdown.

Unlike the credit-to-GDP gap, reported for the second quarter, this study looks at household debt over a longer timeframe.

And the potential impact is high.

"Elevated levels of household debt could pose a threat to financial stability, defined here as distress among financial institutions," BIS economist Anna Zabai said in the report.

"In most jurisdictions, this is chiefly because of sizeable bank exposures."

Fat debts can, of course, also lead to a pullback in consumer spending. And, Ms. Zabai noted, they "can make a household less mobile, and hence less able to adjust by finding a new or better job in another town or region."

The fate of the housing markets also plays into all this. Vancouver is already rebounding from its policy-induced slump, and economists believe Toronto will follow the same course.

The Bank of Canada has been keeping a close eye on debt, and is watching to see how this year's two rate hikes are affecting consumers. It's watching, too, for the impact of the new mortgage measures.

At some point next year, the central bank will again raise its benchmark overnight rate from its current level of 1 per cent, further pressuring many already vulnerable families buried in debt.

As many studies have shown, Canadians are among the most debt-burdened consumers in the world.

"Contrary to the U.S., Canadians have been increasing leverage since the [Great Financial Crisis]," said Citigroup economist Dana M. Peterson, noting that about two-thirds of this borrowing is mortgage debt and much of the non-mortgage credit is in the form of HELOCs.

High home prices are largely behind the elevated debt-to-disposable income measure, she said, attributing the housing market's run-up to low interest rates, rising incomes, strong commodity prices before the oil shock, migration and immigration, land restrictions, HELOC-friendly policies, speculation and foreign money.

As many observers have noted, the potential trouble among highly indebted households as interest rates rise should not be taken lightly. The Bank of Canada certainly isn't taking it lightly as the cost of juggling debts is also expected to climb.

"We expect the debt-service ratio to levitate in lock-step with interest rates over the next few years," Ms. Peterson said in her report, projecting the overnight rate will rise to 2.75 per cent by 2020, thus adding to the impact of the Bank of Canada's moves and the Federal Reserve's effect on bonds.

The debt-service ratio – that's the amount we pay in principal and interest, as a percentage of disposable income – is now 14.2 per cent. Ms Peterson expects it to rise to 16.5 per cent along with the rate hikes.

"The pass-through of monetary policy tightening this year (BoC; Fed via higher global bond yields) has been quite modest on average, but households (one in three) are beginning to complain about higher lending rates, especially those seeking new mortgage loans," she said.

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Trade talks uncertain

The fate of expected free trade talks between Canada and China is now uncertain after Prime Minister Justin Trudeau emerged from a meeting with Premier Li Keqiang to announce the two countries will merely keep exploring whether to launch negotiations.

It had been widely anticipated that Canada would become the first Group of Seven country to commence free trade talks with China, The Globe and Mail's Steven Chase and Nathan VanderKlippe report from Beijing.

Signs that something was wrong emerged throughout the day in Beijing, with Canadian political staffers and diplomats unable to confirm a schedule, or whether the two leaders would take questions.

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Markets at a glance

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What to watch for this week

The Bank of Canada is the main act, with a rate decision Wednesday, but don't expect any change.

What markets are looking for are signals as to when governor Stephen Poloz and his central bank colleagues could resume their rate-hiking cycle.

There are also economic indicators from across the globe and a smattering of quarterly corporate results. Of course, given that we're in the final stretch of the year, analysts are already looking toward earnings next year, and what they could mean for stocks.

"Global equities continue to grind higher, with broad-based support from key [developed market] indices," said John Normand of JPMorgan Chase.

"Earnings are likely to remain a tailwind for global equities in 2018, which should limit the size of any potential drawdowns," he added.

Which should make President Donald Trump happy because he can then claim credit for a happy stock market every chance he gets. But hold that thought …

"Equity markets were upbeat [last] week as an abundance of positive economic data and growing optimism over U.S. tax reforms pushed major market indices to new highs prior to the Friday pullback," said Bank of Montreal economist Carl Campus.

"While investors had largely shrugged off further threats from North Korean missile tests, news that former U.S. national security advisor Michael Flynn would plead guilty to 'willfully and knowingly' making false statements to the FBI ratted markets on Friday, as it opened the door to further scrutiny of the Trump administration's involvement with Russia during the 2016 election."

The calendar:

Tuesday: Mind the gap

President Trump will no doubt be watching closely for his favourite stat, the U.S. trade gap.

Economists expect this October reading will show a fatter deficit of $46-billion (U.S.) to $47-billion, giving the president another opportunity to rail against unfair trade practices and deals like the North American free-trade agreement. (And to try to divert attention from those nasty Russia developments.)

"A wider goods trade deficit in October suggests the overall gap rose to $47-billion from $43.5-billion in September," said BMO senior economist Sal Guatieri.

"Goods exports slipped last month, while imports surged for a second straight time possibly due to the firmer greenback and the end of earlier storm-related disruptions. After adding to GDP growth the past three quarters, trade looks to have taken a sizeable 0.5-per-cent bite out of Q4's pace."

At the same time, Statistics Canada reports what economists expect will be a slightly narrower trade gap of $2.6-billion to $2.9-billion.

"Trade has been nothing short of awful in recent months, and we look for at least a little bit of reprieve," said Benjamin Reitzes, BMO's Canadian rates and macro strategist.

"The loonie's pullback in October might have helped somewhat, but not nearly enough to make a big impact."

Down under, it's always worth watching the Reserve Bank of Australia's rate decision because of the economy's comparisons to Canada. No rate change is expected.

On the corporate side, Bank of Montreal and Laurentian Bank of Canada report fourth-quarter results. As does Roots.

Wednesday: Waits and measures

The Bank of Canada's Mr. Poloz is going to wait it out.

The central bank signalled at its last outing that it's taking a breather after two rate hikes, so economists expect no change in the benchmark overnight rate from its current 1 per cent.

Mr. Poloz wants to see how those two increases are playing out, and how NAFTA negotiations will play out, as well.

Bank of Canada governor Stephen Poloz

The rate decision also follows two key readings released Friday – third-quarter economic growth at an annual pace of 1.7 per cent, and job creation in November of 80,000 positions and a drop in unemployment to 5.9 per cent.

"These reports will not go unnoticed by the Bank of Canada when deciding on interest rates," said Toronto-Dominion Bank economist Dina Ignjatovic.

"Strength in the domestic economy, characterized by solid job and wage gains, appears supportive of higher rates, with a rate hike likely in the coming months."

Today also brings a look at the U.S. labour market with the November ADP report, which comes in advance of Friday's government report and is expected to show about 188,000 jobs created.

Statistics Canada also releases its third-quarter look at labour productivity, which observers expect to show a drop of 0.5 per cent from the second quarter.

The Reserve Bank of India meeting will also be worth watching given that it's expected to hold its key rates steady and "defy government calls for further monetary loosening again," said Shilan Shah of Capital Economics.

Plus, we'll get the measure of some key retailers, with quarterly results from Hudson's Bay Co. and Lululemon Athletica Inc.

Lululemon Athletica logo outside a store on Newbury Street in Boston, June 5, 2017.

Thursday: Tea …

We'll get the first of two readings of the housing market as Statistics Canada reports October building permits that are expected to be little changed from a month earlier.

Plus we'll see another estimate of third-quarter growth in the euro zone, though no revision is expected from the earlier reading of 0.6 per cent. Japan also reports a revised reading, which could show slightly faster growth.

And quarterly results from DAVIDsTEA Inc., Canadian Western Bank and Dollar General Corp.

Friday: … and sympathy

Have some sympathy for Mr. Trump as China reports its latest trade numbers, frequently cited as an irritant.

Economists expect Beijing to report that growth in both exports and imports slowed in November.

"Admittedly, the manufacturing [purchasing managers indexes] point to broadly stable foreign and domestic demand," said Chang Liu of Capital Economics.

"But these surveys appear to have overstated the strength of industry recently, so we wouldn't be surprised if the trade data disappoint."

Of course, what's disappointing for Beijing may still be an irritant for the Trump administration.

President Donald Trump walks on stage to speak at a fundraiser at Cipriani in New York, Saturday, Dec. 2, 2017. Trump is attending a trio of fundraisers during his day in New York

The day's biggie is the U.S. November employment report, and a gain of somewhere around 200,000 jobs is expected, with unemployment holding at 4.1 per cent.

"Following [Federal Reserve chair Janet] Yellen's recent upbeat testimony on the economy, the expected solid jobs report should seal the deal on a Dec. 13 rate hike," said BMO's Mr. Guatieri.

And the second look at the housing market, with Canada Mortgage and Housing Corp.'s measure of November construction starts. Expect a steady annual pace of about 220,000, said Nick Exarhos of CIBC World Markets.

"Permits have been running at a strong 220,000 to 230,000/month clip, and mild November weather will have allowed builders to break ground at a healthy pace."

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