The mood soured on Wednesday as the Federal Reserve predicted that much higher interest rates would be needed to suppress inflation. The central bank also predicted that US economic growth would slow to a meager 0.2 per cent this year – unwelcome news for Canada’s biggest trading partner. How vulnerable are Canadians to a recession? So far, the average household seems to be doing just fine. But undoubtedly, the risks are growing. And the longer it takes to curb inflation, the more collateral damage could spread through the economy. Here are eight metrics to watch for signs of distress.
Wealth
Canadians are experiencing a wealth shock. Their collective net worth – that is, total assets minus liabilities – fell by nearly $1 trillion in the second quarter of this year, a 6.1 percent drop from the first quarter that ranks as the biggest drop on record. The upside: Households remain much wealthier (about $3 trillion) than before the pandemic. Attention, the customization is not over. Home prices continued to fall in the third quarter as rising interest rates cooled the housing market, from which Canadians derive most of their net worth. This could make people think twice before making big purchases. “Higher interest rates make households look and feel less wealthy, and will also increasingly reduce purchasing power,” Royal Bank of Canada economist Claire Fan wrote in a recent report.
Debt payments
Canadians have racked up debt because of the pandemic. They now owe about $2.8 trillion, up 16 percent since the end of 2019. As interest rates rise, households devote more of their budgets to repayment. In the second quarter, the debt service ratio – total mandatory principal and interest payments as a percentage of disposable income – was 13.6%. That’s lower than before the pandemic — but maybe not for long. Toronto-Dominion Bank economist Ksenia Bushmeneva expects the debt service ratio to hit a new record early next year. It estimates that for the average borrower, debt service costs could increase by $2,500 a year by the end of 2023, compared to early 2022. Even if Canadians can afford those higher payments, it could to crowd out other markets.
HELOCs
Canadians love to use their homes as piggy banks. Specifically, they take out loans secured against their homes, otherwise known as home equity lines of credit. The amount owed on HELOCs continues to grow. As of the fiscal third quarter, which ended July 31, Canada’s Big Six banks reported domestic HELOC balances totaling $265 billion, up from $228 billion three years earlier. Interest payments are tied to a bank’s prime rate, which has risen significantly as the Bank of Canada raises its policy rate. A three percentage point increase in the prime rate since March 1 means interest-only HELOC payments have doubled, from about $246 a month to $496 a month, per $100,000 borrowed.
Bankruptcies
Typically, bankruptcies increase during a recession. Not in the COVID-19 recession. Governments supported personal incomes through pandemic stimulus programs, which contributed to lower rates of insolvency (proposals and bankruptcies) and poverty. As these programs ended, consumer insolvencies began to rise again. But these levels remain modest – especially when measured against Canada’s rapidly growing adult population. Delinquency rates, or payments that are more than 90 days late, are rising for many types of loans, but are no worse than in the pre-pandemic years. The numbers show that Canadians aren’t in financial trouble – at least not yet.
Nuclear inflation
The good news on inflation: Annual interest rates are easing in the United States and Canada. The bad: Other measures to boost consumer prices are proving sticky. For example, US core inflation – which excludes food and energy – accelerated in August. Canada saw a slight hold in core inflation last month, but nowhere near levels that will please the Bank of Canada. This raises the possibility that major central banks will continue to raise interest rates to tame inflation. For its part, the Bank of Canada doesn’t see inflation returning to its 2% target until late 2024. The situation is putting a lot of pressure on Canadians who, for the most part, haven’t seen their wages sustained by increases prices.
Consumption
In general, Canadians are mostly dealing with inflation. Retail sales reached $63.1 billion in June, up 11 percent from a year earlier. After inflation, retail volume increased by 1.9%. In other words: Households are spending more, but haven’t started buying yet less material. That may change soon. In a preliminary estimate, Statscan said retail sales fell 2 percent in July. The lower gas prices that month probably had an exaggerated effect. But analysts will be looking for any signs that consumers are cutting back on purchases amid strong inflation and rising borrowing costs.
Rent
Home prices have fallen since February in many markets. But with mortgage rates rising rapidly, Affordability is actually getting worse. This is putting even more pressure on a rental housing market that is chronically underserved in major cities and absorbing record flows of newcomers. In turn, rents are rising almost everywhere. The average asking price for all property types in Canada is up 11.1 per cent from a year ago, according to data from Rentals.ca. For one-bedroom units, increases are particularly sharp in London, Ont. (36.9%), Calgary (29.8%) and Vancouver (18.8%). Of course, many tenants are covered by rent control laws that limit annual increases. But for those moving houses, the market is extremely competitive and getting more expensive.
Job requirement
As the economy cools, so does the demand for labor. Job postings on Indeed Canada have weakened since May, but remain significantly higher than before the pandemic. There are many help desks out there, especially in industries with an overwhelming shortage of workers, such as healthcare and hospitality. Even so, the labor market is undergoing an adjustment. Canada has lost jobs for three months in a row – this usually happens in a recession – and the unemployment rate has risen to 5.4 per cent, not far from a record low. Time will tell if the adjustment is brief or leads to widespread layoffs. In the state, the situation is complicated. Despite intense debate over whether the US has entered a recession, employers there have added more than 3.5 million jobs this year so far. And excessive hiring doesn’t exactly go hand in hand with an economic downturn.
