We have become a little complacent. Interest rates have been so low for so long it seems a little like a "Chicken Little" scenario. We've been saying rates could go higher for so long that it’s not surprising the warnings are being completely ignored.
Report after report suggests Canadians are piling on debt at unprecedented levels with consumption showing no signs of abating. Statistics Canada recently reported the credit market debt-to-disposable income ratio for the average Canadian hit a record 167.3 per cent in the fourth quarter. This means that for every dollar of disposable income, the average individual has $1.67 of debt. Canada is witnessing the largest increase in household debt relative to income of any major developed country since 2000. We simply can't stop spending. MNP Debt says that three in 10 Canadians would take on more debt if rates go even lower. That of course is one of the big concerns for the Bank of Canada.
According to TransUnion, approximately one million Canadian borrowers would not be in a position to absorb an increase in their monthly payments if interest rates were to rise just one per cent. The number of Canadians headed for big trouble has topped 7 million given the fact they carry a variable-rate mortgage or a line of credit with a variable rate -- two products impacted immediately by higher rates.
So here we go again. One more time -- a warning. The Bank of Canada held its key interest rate today but it is important to recognize recent data points ranging from recent GDP gains to rising employment that suggest the economy is getting stronger not weaker and that means the Bank of Canada could move rates higher sooner than later.
“When young people especially look at interest rates, they kind of expect that they’ll be able to react in a calm, positive way the them," Gordon Reid, president and CEO of Goodreid Investment Counsel, told BNN Wednesday morning. "They expect them to move in a linear manner. That’s not the history of moves of any market, including rates. They tend to trap you. They trap you by moving too far too fast.”
“We’ve seen it many, many times and I think it’s a big danger,” he added.
Are you ready for higher rates?
Whether the Bank of Canada moves on interest rates or not we should all understand the impact. For those owing money it becomes more expensive resulting in less disposable income as it costs more to service your variable rate debt. For investors, bond yields have already begun to move higher and given the Trump wildcard for now you may want to stay short rather than long and consider tilting toward corporate bonds with solid credit ratings over government issues to pick up a better return.
Interest rate movements will have an impact on both sides of our balance sheets. Yet at the end of the day no one can consistently get it right trying to time the market. So precaution is warranted. Borrowers beware the odds are stacking up against you and complacency could lead you into a hole that is much deeper than you thought. Ensure now that your cash flow can support the debt levels you are carrying. For investors, diversify your holdings among different types of bonds like corporate bonds, government bonds, real return bonds and high yield bonds. This will help you manage the spreads across the yield curve.
We all should worry less about trying to time interest rates and markets and focus more on maintaining balanced portfolios that reflect our personal needs and objectives. Sadly for some, the improving health of the economy isn't reflected in an improved personal balance sheet.