June 15, 2022
Market Trends
RYPM
Low rates
and the promise of riches from ever-rising home prices sent Canadians on an
epic debt binge. Statistics
Canada (Stat Can) data shows the household debt to disposable
income ratio tied the record in Q1 2022. A tie might sound like we’ve seen this
before, but interest rates make this situation stand out. Having such a high
ratio at this level, it’s easy to see why inflation is soaring. It’s also easy
to see why rising rates are going to be a much bigger drag on the economy this
time around.
Canadian
Households Owe $1.80 For Every $1 They Earn
Yet another
indicator showing Canada’s epic debt binge surfaced this week. The ratio of
household credit market debt to disposable income hit 180.2% in Q1 2022. It’s
an increase of 0.9 points from the previous quarter and 10 points higher than
last year. More bluntly, households owe $1.80 in debt for every dollar of
disposable income they make. It’s a lot of debt.
Debt To
Income Ratio Growth Slowed, But Still Strong
There’s bad
news and good… well, less bad news. The bad news is the increase is the most
points gained for the ratio in a 12-month period, going back over 30 years. Nothing
even close to a 10.1 point increase has appeared since 1990, as far back as the
data goes. Remember, this means household debt grew 10 points faster than
income.
A mixed
point, depending on who you are, is that the ratio has begun to decelerate.
Growth was progressively smaller over the past 4 quarters, with Q1 2022 less
than a fifth the size of Q2 2021. Peak growth is now behind us, though credit
is still outpacing income.
On one hand,
a slowdown can seem good. Households aren’t approaching a precarious situation
at such a rapid rate. However, if economic growth was fueled by a debt binge, a
credit slowdown can mean the economy slows. That’s the big issue with
credit-driven recoveries in a nutshell. A boom-bust trajectory is fast but
causes the most damage to households.
Canada’s
Economy Likely To See A Bigger Drag This Time Around
As mentioned
earlier, the debt-to-income ratio is tied with a previous record. The
assumption might be, oh — we tackled the issue just in time, right? It was only
Q4 2018 when the previous high was reached, and the overnight rate was 1.75%,
the neutral policy rate. At neutral, monetary policy no longer stimulates
credit growth. Below the neutral rate is like pouring gas on a fire, which is
where Canada is.
The data
reported in Q1 2022 shows the ratio was reached with the overnight rate peaking
at 0.75% in the quarter. While it has since climbed to 1.50%, the neutral rate
is now estimated to be in the range of 2.0% and 3%. Credit is still receiving
stimulus to grow, with annual growth remaining quite high. A lot of complaining
about higher interest rates doesn’t change that it’s still below 2019 levels,
with inflation at a 30+ year high.
The sensitivity of this debt is the most important takeaway. It might be the same ratio as in 2018,
but the circumstances are very different due to interest rates. As interest
rates rise to the neutral level, more capital will be required to pay off the
debt. Future economic growth was borrowed to create inflation… and they may
have gone a little overboard, to say the least.
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