Thoughts

October 18, 2024 | 15:21

Cdn Consumer Sinking, but U.S. Wants to Swim

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Don’t underestimate the U.S. consumer, they say. The Canadian consumer? Go ahead. A strong U.S. retail sales report for September further highlights the disparity in spending strength on the two sides of the border, which has weighed heavier on Canadian growth and contributed to earlier easing by the Bank of Canada—the divergence probably isn’t going to unwind in the near future.

U.S. retail sales excluding gas were up a solid 2.7% y/y, 2 ppts stronger than in Canada. That’s a pretty stark contrast, especially considering the explosion in the Canadian population. In per capita terms, retail spending has maintained a solid growth clip in the U.S. while contracting outright in Canada since early 2022, with similar trends holding for real per capita consumption. Unsurprisingly, the widening of that performance gap neatly coincides with the start of the tightening cycle.

"What's wrong? What's going on?" Canadians are more levered in terms of household debt relative to disposable income. Recall that U.S. households spent a decade deleveraging after the financial crisis, while Canadians continued to borrow more. Indeed, as the U.S. household debt-to-disposable income fell from near-170% in 2008 to 127% today, Canada’s ratio has risen from 135% (2008) to a record-high 170% in 2022 (down to 160% today). As debt levels went in different directions, it gradually gave U.S. households more flexibility to borrow and handle higher interest rates. While the U.S household debt service ratio is down more than 4 ppts from the 2008 highs, Canada’s is pushing record levels at nearly 15 cents per dollar of disposable income.

Not only is the debt burden larger, but the sensitivity to higher interest rates is arguably higher in Canada. While many U.S. households locked in historically-low mortgage rates for 30-year terms during the pandemic boom, Canadians poured into mortgages at rates that proved to be a tease. Those variable-rate and short-term fixed mortgages will continue to renew into higher rates through 2026, with monthly payments resetting, very roughly, 15%-to-50% higher. The nature of the reset cycle makes this a longer headwind for discretionary spending even as rates come down.

Now, consider the buffers before smashing the sell button. Canadians will pay that mortgage first, and they’ve been stress tested to do so. A borrower at a federallyregulated institution who borrowed at 1.5% in 2022 was stress tested at 5.25%, and the recent decline in interest rates has renewal rates tracking below stress-test levels—that’s an important development. At the same time, real wage growth has turned positive, and growth over a five-year term acts as another cushion. While this will buffer the system and limit delinquency, households do still have to make the payment, leaving fewer trips to the mall/restaurant/travel agent.

More debt and higher interest-rate sensitivity are weighing more heavily on Canadian discretionary spending. That should continue in the near term, and is consistent with a lower expected path for BoC policy rates than for the Fed through 2026.