Canada would be hit harder by recession than the U.S.: RBC
The recent yield curve inversion has renewed speculation about a potential North American recession and prompted questions about how a contraction would affect households.
Though it’s impossible to say for certain when, or even if, such an event will occur, several indicators suggest the pain would be more severe on the Canadian side of the border than in the U.S.
Eric Lascelles, chief economist at RBC Global Asset Management Inc., which oversees $430 billion, says while he doesn’t see signs of a debt crisis in the making, Canada’s households are clearly more stretched in terms of debt and spending than their American counterparts.
“There’s just no latent capacity to spend or to buffer a shock in Canada, and the U.S. is very well positioned,” Lascelles said by phone from Toronto. “You could lose your job and you would be okay in the U.S., or rates could go up and you’d be fine, or the economy could turn down and spending could continue. In Canada, you can’t really say that.’’
Here are three indicators that show why financial strains are higher in Canada -- and one that shows why the country’s vulnerability to a shock may actually be receding.
Canada’s household savings rate fell to 1.1 per cent in the first quarter. “That’s about as low as it gets, historically,” said Lascelles. It compares with 6.7 per cent in the U.S. The disparity between the two rates hasn’t been this wide since the 1970s. The lower the savings rate, the less of a cushion households will have to weather tough economic times.
“If there were to be a recession, whether it’s in 2019 or 2029, or sometime in between, you can imagine Canadians getting hit a little harder than Americans,” Lascelles said in a separate webcast. “They just have less room for error, less room to cushion any kind of hit with spending, before they would actually fall into outright dissavings.”
Canada’s ratio of debt to income reached 176 per cent in the fourth quarter, among the highest in the developed world. That compares with a U.S. rate of 133 per cent. Canada’s households are “substantially more leveraged” than those in the U.S., Lascelles said.
Debt Service Ratio
In Canada, the debt service ratio -- the amount of disposable income that goes to paying interest and principal on debt -- climbed to 14.9 per cent in the fourth quarter, the highest since 2007. “It’s about as much money as people have spent servicing debt, on an interest plus a principal basis, since records began in 1990,” Lascelles said. “That’s a concern.”
Because the countries measure the DSR differently, finding a direct U.S. comparison is tricky. According to data from the Bank for International Settlements, which applies a common methodology across countries, the debt service ratio of 13.3 per cent in Canada compares with 7.9 per cent in the U.S., another sign Americans have more room to breath should economic conditions deteriorate.
On the flip side, Canadian household debt vulnerabilities have improved, Lascelles said, citing an indicator called the Credit-to-GDP gap developed by the BIS. The metric shows how fast credit is rising relative to normal.
“It doesn’t look as though an utter disaster is in the offing,” Lascelles said. “The vulnerability seems mostly to do with how quickly the household credit is accumulating, compared to normal. It’s not whether you have a lot of debt, it’s whether you accumulated it recently. In Canada’s case, most of the accumulation was a while ago.”
If the housing market implodes -- which Lascelles isn’t expecting -- it would be the people who got in last who would be most vulnerable, he said, because they would have the lowest equity stake and they would be underwater on their mortgage first. “And so to the extent we haven’t seen credit grow as quickly, there aren’t as many households that are vulnerable.”
He added: “It’s not obvious there’s a debt crisis in the making though. It’s just one that’s going to limit consumer spending and limit the economy more generally.”
--With assistance from Erik Hertzberg