Provincial Credit Watch
March 05, 2025 | 11:12
Provincial Credit Watch: March 2025
Economics
Economics
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Provincial Returns |
Long provincial returns were positive over the past month as a rally in GoC yields outweighed wider spreads. Risk appetite has been impacted by the Canada-U.S. tariff battle, with 25% U.S. tariffs on all Canadian imports (10% for energy) going into effect on March 4th. With the economic impact on Canada likely to outweigh the inflation impact, 10-year yields fell sharply to below 2.8%, the lowest level in almost two years. Long provincial spreads widened by roughly 4 bps since the end of January, but are still trading right in the middle of the range seen over the past three years. That leaves total provincial returns over the past 6- and 12-month periods still well in positive territory at +5% and +8.7%, respectively. |
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Relative Performance |
Long provincial spreads were wider across the board in the past month. While a weaker risk appetite is lifting spreads across the board, provincial budgets so far have forecasted wider deficits. Alberta's is notably expecting to swing from a $5.8 billion surplus in FY24/25 to a $5.2 billion deficit in FY25/26. But, the province is building in a full range of tariffs. Contrast that to B.C., where the deficit widens to $10.9 billion despite the Province not building in any tariff action. This discrepancy on the treatment of tariffs will continue to cloud relative fundamentals given that each province is taking a somewhat different approach. For what it's worth, we see upside in Alberta's numbers, but downside to those in B.C. |
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Fundamentals |
Economic Impact of TariffsFully appreciating that the tariff situation could have evolved by the time you read this, we cut our Canadian economic outlook in response to the tariffs and retaliation that went into effect on March 4th. We estimate that the tariffs will reduce real GDP growth by roughly 1.5 ppts to around 0.5% in 2025. And, we now look for the quarter-point pace of Bank of Canada rate cuts to continue in each of the next four meetings, taking the rate to 2.0%. The net risk is that we eventually go even lower, if the Bank is comfortable with the prevailing inflation backdrop later this year. Direct exposure to U.S. trade varies across the country, and so will the impact. B.C. carries a relatively low share of goods exports in its economy, and roughly half of those are destined for markets outside the U.S, but some industries (e.g., forestry) will come under duress. Alberta, Saskatchewan and Newfoundland, because of hefty energy exports, carry the largest exposure (exports to the U.S. are 20%-to-35% of GDP); but, the lighter 10% tariff on such products, and the assumption that a portion will be passed to the U.S. consumer, leaves the impact to run smaller in these provinces—at least in the short run. Non-energy U.S. export exposure is highest throughout Central Canada. In Ontario, for example, U.S. goods exports top 17% of GDP with a wide range of industries exposed (e.g., autos, machinery, metals and consumer goods). Quebec’s industrial metals and manufactured goods will be vulnerable, as will Manitoba’s diverse manufacturing base. Atlantic Canada is susceptible because of a few highly-concentrated industries, even if the broad economic impact appears smaller—think the Newfoundland & Labrador fishery, and PEI packaged food goods. All told, we expect the economic impact to hit hardest in Ontario and the rest of Central Canada; significantly impacting some concentrated industries in Atlantic Canada and B.C., while dealing a lesser immediate blow in oil-producing provinces. Provincial Finances Meet Tariff UncertaintyThe combined provincial budget deficit for FY24/25 (ending March 31st) is on track to widen to $21.0 billion from $9.0 billion in FY23/24. The deterioration has come on multiple fronts. Revenue growth, which had been robust thanks to the post-pandemic recovery and high inflation, has cooled amid softer economic growth, although some provinces have seen in-year improvements versus their budget plans. Meantime, program spending growth remains firm, partly reflecting upward pressure on public-sector wages, while interest costs are also on the rise. Every province in Canada, with the exception of Alberta and Nova Scotia, is currently forecasting a deficit for FY24/25, so this is not a case of one or two large outliers. That said, the combined provincial deficit still weighs in at a modest 0.7% of GDP, or less than half of the 1.6% seen at the federal level. With the exception of British Columbia (2.1% of GDP), all provincial deficits currently weigh in below the federal mark. Looking to the upcoming fiscal year (FY25/26), it’s a mixed picture as some underlying deficit improvement meets an uncertain economic environment and potential stimulus in response to any tariff action. In the event of 25% tariffs imposed on Canadian imports by the U.S. (10% for energy), and retaliation from Canada, most provincial deficits would widen—especially those in Central Canada with higher non-energy U.S. export exposure. As an example, Ontario’s ‘slower growth’ scenario published in Budget 2024 somewhat resembles our view on the growth impact of such tariff action, including a contraction in year one and below-potential growth in year two. There, the provincial deficit would deepen by roughly $5 billion (0.4% of GDP) per year in the first two years. Others like Alberta, where we see a much smaller economic impact, should face a much smaller fiscal impact as well. Lower oil prices could emerge through a wider light-heavy differential, but a weaker loonie would be a significant buffer. The stimulus response would layer on top of that, and the size is anyone’s guess at this point. Some early chatter of a pandemic-like response has cooled down, even in free-spending British Columbia. We’d also likely see the fiscal response tilt more toward permanent growth-enhancing policy changes rather than direct temporary support. At any rate, we could very well see the combined provincial deficit push above 1.5% of GDP in the event of a prolonged tariff battle, leaving total borrowing requirements to challenge the approximately $150 billion all-time high seen in FY20/21. Note that the current-year pace is running at about $130 billion, but a number of provinces have been pre-funding anticipated requirements for the upcoming fiscal year (the combined FY24/25 program is almost 110% funded). All that said, we still might not even go down that road. To account for the uncertainty, look for the provinces to flesh out some of these scenarios in their 2025 budgets, or build in larger contingencies. We suspect that some provinces will publish full downside, or trade-war, scenarios in their fiscal plans; we’ve already seen Nova Scotia (the first budget tabled) build in a contingency line for the first time; and Alberta went ahead and assumed tariffs. |
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Budget Season NotesThe Province of Alberta is projecting a $5.2 billion deficit in FY25/26, or just over 1% of GDP, a significant swing from a $5.8 billion surplus now estimated for FY24/25—but the bar appears to be set very low. Indeed, the budget effectively builds in significant tariff action, a resulting economic slowdown, widening of the light-heavy oil price differential, but with limited impact on the Canadian dollar, all while also incorporating a further $4 billion contingency. That said, the large contingency will also be used to cover the impact of public bargaining settlements so, while it's easy to cast all the blame on tariffs, there is actually some upward pressure on spending for a government that doesn't love to show an eagerness to spend. Still, if the economy doesn't get hit hard on trade, there is meaningful upside to this fiscal outlook. Full analysis here The Province of Nova Scotia is projecting an $898 million deficit in FY25/26 (1.4% of GDP), a notable turn after four consecutive years in the black. The FY24/25 balance is now pegged at a small $82.4 million surplus, improved from the latest quarterly estimate of a $247 million deficit. Nova Scotia has seen strong revenue upside through the fiscal year, but will ramp up spending in a number of priority areas, and implement a sales tax cut. Full analysis here The Province of British Columbia is projecting a $10.9 billion deficit in FY25/26, or a chunky 2.5% of GDP. By FY27/28, the province still sees a large $9.9 billion shortfall, with the end of the forecast again running meaningful larger than previously expected ($6.1 billion). The budget was also based on an underlying economic outlook void of any tariff action, which leaves it exposed to some downside risk. The Province outlines a downside scenario that could see revenues hit by roughly $1.7-to-$3.4 billion, but also continues to maintain large contingencies in the spending plan. Those contingencies total a hefty $4 billion for FY25/26 and can be used to shape evolving spending priorities. Still, with bigger and persistent deficits, as well as a record $31 billion borrowing program, B.C.'s net debt-to-GDP ratio will continue to rise, sitting at 25% of GDP this coming fiscal year, and rising above 32% by FY27/28—into the league of Central and Atlantic Canada for the first time. |
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Recent Publications of Interest25% Tariffs: What If? We judge that a 25% tariff could pull Canadian growth down by nearly 2 ppts and weigh on the loonie, but monetary and fiscal policy would not stand still. Full analysis here. Provincial Monitor: Most provinces are expected to see growth improve in 2025, but a set of major macroeconomic factors could make for an interesting landscape. Full analysis here. Housing Outlook: A Long Way Home: The Canadian housing market should post modest sales and price gains this year, but don’t expect another exuberant takeoff. Changing secular forces also suggest it’s still a long way back to the 2022 highs. Full analysis here. What Canada’s Immigration Shift Will and Will Not Do: Ottawa’s dramatic about-turn on immigration will turn Canada’s fiery 3%+ population growth of the past two years to an icy near-zero pace in coming years. This may have some important economic effects, but there are already many misleading narratives that have emerged since the announcement. Full analysis here. Canada’s Housing Market in Charts: The following is a chart-based tour of the market as it stands now, and where it might be headed. Full analysis here. Canadian Job Market: “We’ll Be in Touch”: The job market has gone from extremely tight to exhibiting some clear signs of weakness. We explore some of the reasons why, and the implications for policy. Full analysis here. Pathways to Affordability for Canada’s Housing Market: You would need to go back to the era of double-digit mortgage rates in the early 1990s to see the last time buying a home in Canada was as expensive as it is today. The workout last time involved a major price correction followed by a long period of stagnation. Is there a less painful route back to affordability this time, and, if so, how long will it take? Full analysis here. Extraordinary Population Delusions and the Trouble with Crowds: Canada’s population has exploded by 1.3 million people in the past year, or 3.2%, the fastest pace since the 1950s. This surge is rooted in sound principles, but has clearly run amok. Indeed, the narratives around the population boom have, in our view, been off the mark. Here are five pieces of the narrative that are worth challenging. Full publication here. |
FY25/26 Budget ReportsThe Province of British Columbia is projecting a $10.9 billion deficit in FY25/26, or a chunky 2.5% of GDP. Full analysis here The Province of Alberta is projecting a $5.2 billion deficit in FY25/26, or just over 1% of GDP, a significant swing from a $5.8 billion surplus now estimated for FY24/25. Full analysis here The Province of Nova Scotia is projecting an $898 million deficit in FY25/26 (1.4% of GDP), a notable turn after four consecutive years in the black. Full analysis here |