Why Canada’s housing and household debt risks remain contained

December 12, 2019 Rachael Moir

This article appears as published in the Globe and Mail and Rachael Moir is the byline

Canadian households carry notoriously high levels of debt, making them and the financial system particularly vulnerable in the event of an economic recession.

Loans to households total a whopping $2.3-trillion, two thirds of which are mortgages, illustrating the extent of the influence of the housing market on Canadians’ wealth.

But debt is only one aspect of the equation. When considering the income side as well, the picture reveals that risks remain contained.

Here is why.

Slower but supportive growth conditions

Economic conditions generally support housing and household income prospects in Canada. Despite the increased risk of a global recession, we still expect global and U.S. activity to expand next year, which should allow Canada to avoid a recession. U.S. real GDP grew 2.1 per cent in the third quarter, led by consumer spending, a stronger showing than the initial 1.9-per-cent estimate.

In Canada, third quarter real GDP expanded at an annual pace of 1.3 per cent. While this is a slowdown from the previous quarter, it was mostly due to a 0.4-per-cent drop in exports. Households, on the other hand, boosted their spending, as consumption rose 0.4 per cent after a modest 0.1-per-cent increase in the second quarter.

Fiscal policy could be another source of support for Canada’s economy. The re-election of Prime Minister Justin Trudeau with a minority government increases the odds of more fiscal stimulus in the near term, even in the absence of a recession, in an effort to appease minority parties.

Income growth catching up to debt growth

Economic expansion, albeit at a slower pace, should support labour market conditions and households’ income, hence their ability to repay their debt.

At 5.5 per cent, the unemployment rate remains close to a historical low, with a participation rate above the 20-year average.

Canadians are also seeing wage gains accelerate, with average hourly earnings up 4.4 per cent year-over-year in October. This trend could continue as the Bank of Canada found in its Autumn Business Outlook Survey that indicators of labour shortages point to tighter labour market conditions in most regions except the Prairies.

Since March 2019, year-over-year wage increases have, in fact, outpaced house price appreciation.

Overall, household income growth has been catching up to the pace of debt growth over the past year, with incomes rising nearly 3.6 per cent year-over-year in the second quarter from a low of 2.8 per cent in the third quarter last year. Meanwhile, debt growth has been hovering within a range of 3.4 per cent to 3.8 per cent.

Now, income and debt growth rates are more in line than they were just a year ago.

Statistics Canada estimates that disposable income also rose faster than nominal household spending in the third quarter, resulting in a higher saving rate.

Also reducing the risk of debt growth drifting uncontrollably higher, Bank of Canada Governor Stephen Poloz has indicated his ongoing desire to avoid fueling household debt levels through lower interest rates.

Easing financial conditions

While the Bank of Canada’s policy rate is the highest among G7 countries, financial conditions have eased as part of a global trend. The Canadian 5-year yield, the most common reference for Canadian mortgages, is now below 1.5 per cent, compared to 2.3 per cent a year ago.

Trade tensions and global uncertainty remain a headwind that should prevent a sharp increase in long-term rates, helping borrowers’ long-term debt paying ability.

Trade tensions should also discourage the Bank of Canada from hiking rates, although the central bank is unlikely to ease its policy either in light of tight labour market conditions, near-target inflation and elevated household debt levels.

Improving mortgage debt quality

Tighter regulations are another factor in our housing and debt risk assessment, since more stringent mortgage stress tests have led to a significant decline in new mortgages above 450 per cent of disposable income.

A decrease in high loan-to-income insured mortgages means an improvement in the ability to pay back debt.

Carolyn Wilkins, the No. 2 at the helm of the central bank, also pointed out that the cumulative 50 basis point rate hike in July and October 2018, combined with tax measures, has helped reduce Canadians’ financial vulnerability.

No housing bubble

Despite easing financial conditions, improving mortgage debt quality and tighter labour markets, fears of a housing market bubble bursting have been around for some time now. But in our view, there is no bubble.

Housing price trends remain in line with fundamentals, and indicators of supply and demand point to generally balanced conditions despite regional differences.

On the demand side, Canada’s population growth is the fastest among G7 countries, and above-inflation wage gains are supporting household income.

Supply is growing back in line with demand, which should prevent house prices from appreciating at an unsustainable pace. Statistics Canada reported that housing investment rose 3.2 per cent in the third quarter, the fastest pace since the first quarter of 2012, including a 3.3-per-cent increase in new home construction.

So overall Canada’s economic outlook remains constructive for risk assets, although slower growth, a higher recession risk and ongoing trade tensions call for caution.

This is why our exposure to equities focuses on defensive markets relative to more cyclical markets. We also favour developed markets over emerging markets. On the currency side, we still like the Canadian dollar relative to international currencies owing to higher Canadian interest rates and a resilient, albeit slowing, domestic economy.

About the Author

Rachael Moir

Rachael Moir, was a Quantitative Investment Analyst with the Investment Management and Strategy team at MD Financial Management. She was responsible for supporting strategic and tactical asset allocation mandates, alternative investment mandates and MD’s Tactical and Risk Allocation Committee.

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