Jan 22, 2019
Can Canada slip into recession without the U.S.? BCA says yes
There's reasons to be bullish on global equities despite China concerns
Canada’s economy may soon endure something it hasn’t faced in 68 years: A recession without the U.S. in the same boat.
That’s the view of Jim Mylonas, global macro strategist at BCA Research Inc. in Montreal, a firm that’s been making calls on markets and economies since 1949. Mylonas says the surge in household debt combined with rising interest rates will push the Canadian economy into recession, even while the U.S. economy continues to grow.
“I think we’re just on the precipice of embarking on a serious recession,” Mylonas said in an interview from Bloomberg’s Toronto office. “It’s not a matter of if, but when.”
For Mylonas, the irony is that surprisingly strong growth in the U.S. this year may push Canada over the edge. The expansion will force the Federal Reserve and Bank of Canada Governor Stephen Poloz to raise rates, he said. The debt-laden Canadian consumer is ill-equipped to handle higher borrowing costs, unlike their U.S. counterparts who dialed back borrowing following the housing crash a decade ago.
For Mylonas, the good news in the U.S. may be bad news for Canada.
“If the U.S. economy is doing relatively well and the Fed is raising rates, it’s very hard for the Bank of Canada to just sit on hold and not follow the Fed,” Mylonas said. “We’re now at the point where the Bank of Canada is going to be flirting with triggering the next recession if it hasn’t already.”
If Mylonas is right, it would be the first time since 1951 that Canada slipped into a recession without the U.S. also contracting.
Canada’s economic fortunes have always been tightly linked to its southern neighbor, the destination for about third quarters of its exports. The U.S. economy has reduced its imbalances after sparking the worst credit crisis in almost a century, led by a plunge in real estate. In Canada, which largely avoided the crash, corporations and consumers have been piling on debt ever since, Mylonas said.
The debt to disposable income ratio in Canada rose to 175 percent at the end of September, from 137 percent in 2006, before the start of the financial crisis. By contrast, U.S. household debt to disposable income was below 100 percent as of September, the lowest since 2001, according to data compiled by Bloomberg. Even at its recent peak, the U.S. ratio never topped 140 percent.
“In that 10-year period where the U.S. was on a diet, getting healthy, Canada was binge eating junk food, which is debt,” Mylonas said, adding a medical analogy. “Eventually you go to the doctor and the doctor says, ‘sorry, you gotta cut the junk food.’ That’s painful.”
Canada’s housing market is already showing early signs of fatigue, with home sales declining last year to the lowest since 2012, according to Canadian Real Estate Association. The number of consumers seeking debt relief jumped 5.1 per cent in November from a year earlier, the Ottawa-based Office of the Superintendent of Bankruptcy reported on Jan. 4.
“If debt to disposable income is going to go from 180 to 130, then the recovery is going to look a lot more like the U.S. one, so shallow and long,” said Mylonas.
To be sure, most economists and the Bank of Canada aren’t calling for a recession any time soon. The chances of a recession over the next 12 months is about 20 per cent, according to a Bloomberg survey of 10 analysts released Jan. 11. Earlier this month, the central bank cut its 2019 growth forecast to 1.7 per cent, while raising its estimate for 2020 to 2.1 per cent. The chances of a U.S. recession is slightly higher, at 25 per cent, based on 49 estimates.
Investors certainly aren’t behaving as if a contraction is imminent. The Canadian dollar has gained the most among G-10 currencies this year, while the main equity gauge has jumped 7 per cent, the best start to a year since 1980.
Traders aren’t banking on an imminent hike by Poloz, who worked at BCA Research in the 1990s. Chances of an interest rate increase by May sit at about 30 per cent, according to trading on futures contracts.
“If the Bank of Canada is not raising in line with the Fed, the reason it’s not raising is probably rooted in bad news,” such as weak economic growth, said Mylonas. “If that’s the case, then my thesis for Canada will play out sooner than most think.”
--With assistance from Erik Hertzberg and Kristine Owram.