Canada's Day of Reckoning Approaches

Today, the Bank of Canada signaled that it will soon start increasing interest rates.

The Bank of Canada is sending a clear message that interest rates could rise as early as June, signalling a turning point in the recovery and triggering a debate on how fast and how high rates will move.

The central bank kept its key rate steady at the rock-bottom level of 0.25 per cent at its policy meeting Tuesday, but removed key language that had pledged to keep the benchmark at current levels through the middle of the year.

That move contributed to growing expectations that the central bank will raise rates as early as June 1, its next policy decision, and sent the dollar soaring again.

Yet, Canadians have been piling on the debt.

Canadian borrowers are fast approaching a day of reckoning.

Lured by cheap money to buy up, buy in, expand and make over, families have pushed credit levels to a record high.

Now, mortgage rates are beginning to creep up and the Bank of Canada is poised to retreat from the record-low interest rates it adopted to fight the recession and spur recovery.

The end of the free-money era has left consumers more vulnerable than ever, and those who threw caution to the wind could soon face costs they can't handle.

Household debt has surged three time faster than income in recent years and now stands at a record high of more than $1-trillion. Put another way, Canadians owe about $1.47 for every dollar of  disposable income. Even more remarkably, they took on more debt during the slump – a first for a recession – because borrowing was so cheap.

With debt levels this high, even a small hike in interest rates will be ugly for those whose incomes aren't rising fast enough to meet their day-to-day expenses.

Their woes could have a snowball effect: As debt-strapped consumers pull back, their credit woes spill over into the broader economy and risk putting a damper on the recovery. ...

Most of the increased debt, roughly 70 per cent, has been in mortgages, reflecting the still hot housing market in much of the country. That has left many households struggling to meet monthly payments on hefty mortgages and more susceptible to rising rates. Families in Vancouver, for example, spend about 68 per cent of their disposable income on the cost of maintaining their house, compared to less than 40 per cent 10 years ago.

“There's been a real frenzy just to get in [to a house] at all cost, because if you don't get in you may never get in,” said Scott Hanah chief executive of the Credit Counselling Society, a non-profit group based in Vancouver that helps people sort out their debts. ...

Canadians used to be big savers and cautious borrowers. In 1982, Canadians socked away 20 per cent of their disposable income and per capita debt stood at about $5,500, according to Statistics Canada. By contrast, Americans were saving just 7.5 per cent of their disposable income at that time and borrowed $6,500 per capita.

Savings and borrowing soon went in opposite directions in both countries and by 2002 debt levels surpassed disposable income for the first time. In 2005, the savings rate in Canada fell to 1.2 per cent, about the same as in the U.S. Meanwhile, per capital borrowing jumped to $28,390 in Canada and $48,700 in the U.S.

Consumers are feeling the pinch. A survey last year by the Certified General Accountants Association of Canada showed 21 per cent of respondents could barely meet the interest payments on their loans. The group is about to release a similar survey this year and, said the group's chief executive Anthony Ariganello, the level of those struggling to cope has climbed to about 23 per cent. ...

In a recent report, Mr. Tal concluded that “Canadian consumer fundamentals are weaker than they have been in almost 15 years.” ...

We commented about the Canadian Housing Bubble not too long ago.  Canadian mortgage rates are at multi-generational lows.  Even a small rise in mortgage rates will hurt Canadians' pocketbooks. 

Housing bubble.  Rising debt levels.  Sound familiar?  The end game is also likely to be familiar.

Canada has been good, but Canada has also been lucky.  Easy money arising from the Fed's zero interest rate policy has flowed into Canada, arresting the collapse of the Canadian housing market before it really started to accelerate, sending home prices north of the border to record highs.  When money begins to tighten, Canada could become extremely vulnerable.

What could save Canada?  The Fed's zero interest rate campaign to debase the dollar helps real assets, particularly commodity prices, which benefits Canada.  If the Fed's policies remain extremely easy, then Canada's inevitable housing collapse may be buffeted by relatively high commodity prices.

Long term Running of the Bulls readers may think I'm talking my book, as two months ago I stated that I was short Canada.  A few weeks ago, I covered all my shorts and am now long Canada and risk assets in general (ensuring that a correction is imminent - ed.).  Generally, asset markets collapse when monetary policy is tight.  Monetary policy is currently very easy.  Usually, asset prices rise for some time after the first increase in rates by the central bank.  I have been looking for a 5%-10% correction for some time, and that may happen.  However, I expect stocks to be higher in the future.  But at some point in the future, you are going to want to be far, far away from Canadian (and global) stocks.

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