As it stands today…
So, where are we now as we head for the turn of the year? The Bank of Canada has stayed put for three successive meeting at 5%, while the Fed have maintained its benchmark rate in the 5.25-5.5% range since July. It’s the biggest indication yet that the aggressive hiking cycle has come to an end, backed up by clear signals that financial conditions have tightened and the labour markets has softened.
Once again, people foresee a recessionary scenario and the start of a deep rate cutting cycle. But how much of that is optimistic yearning for a return to the low-rate years of the 2010s and how much of that is reality?
From a North American view, for this to happen:
• Growth needs to collapse
• Unemployment needs to rise significantly
• Inflation needs to return to sub 2% levels
There is no doubt higher rates are now having an impact in certain areas – speculative tech firms have nosedived, and commercial real estate is struggling, for example. The Canadian housing market is finally experiencing a price drop and private markets are facing their own pricing wake-up call. But a couple of other factors can offset these pockets of the economy, making dramatic rate cuts more unlikely – these factors should help maintain growth and, therefore, inflation:
• Wage increases have been healthy
• Renewed fiscal spending in healthcare, energy and infrastructure
All this sounds like the economy still has some legs, but the Canada caveat is that household debt levels are the highest in the G7.
As of 2021, the country’s household debt is 7% higher than the country's entire GDP, an increase from 2010, when household debt was about 5% lower than GDP. By comparison, household debt in the US fell from 100% of the country's GDP in 2008 to about 75% in 2021, while the UK's household debt as a share of its GDP also fell from 94% in 2010 to 86% in 2021.
Five-year fixed rate mortgages in Canada, which were negotiated during the low-rate period, are coming to an end at the same time of a softening jobs market, putting more pressure on those household debt levels. Throw into the mix the fact Toronto and Vancouver are among the most unaffordable cities in the world and Canada is more vulnerable than most to another financial crisis.
On the flip side, there is an argument that the post-COVID shutdowns income growth in Canada did not translate into proportional growth in spending, generating an “excess” of savings. The consumer has so far proved resilient, but risks prevail. The good news is that the US consumer, traditionally a huge support to the Canadian economy, has proved steadfast.
In the final post of this three-part series on the direction of interest rates, we will zoom out to discuss what this all means for the average investor in 2024.
