Canadian debt is dirt cheap, but it won’t be this cheap forever, warns BMO. Douglas Porter, the bank’s chief economist, expects the cost of borrowing to remain “low for long.” He just doesn’t see it being quite as low as the current stimulus driven environment. As governments taper stimulus to fund its spending, borrowing rates should rise. This would be true, even if interest rates don’t move from their current levels. Economies that can’t taper stimulus might be getting a little grey in the hair. This would mean significantly slower economic growth going forward.
Deficits Matter, Even If People Say They Don’t
Canada is displaying a lack of urgency to slow government spending, and no party plans to curb that. The bank projects deficit spending will produce a triple digit shortfall of $150 billion (~5% of GDP). Total long-term debt is now just below 50% of GDP, largely supported by below 2% interest rates. We’re still a long-way from having a recovered economy, so the bank isn’t advocating for spending cuts. However, Porter stressed, “deficits do matter.”
In order to fund this spending, interest rates have been suppressed by quantitative ease (QE) — a lot of it. BMO is observing central banks easing the amount of stimulus they deliver. Some have even begun to, *gasp* taper the amount of stimulus used. “Even the ECB [the EU central bank] is now cooling its purchases, even if it doesn’t quite meet the taper bar. We are firmly planted in the low-for-long camp… but not this low,” he said.
Interest Rates Don’t Need To Rise For Debt To Become More Expensive
QE is used when inflation won’t rise, and a central bank’s rate is close to zero. By pouring a whack of money into the bond market, they shrink yields below the usual premium. By tapering (or ending) QE, rates can rise without a hike to the overnight rate. This can have a similar impact to borrowers as a hike to the overnight rate, due to servicing cost.
It doesn’t matter why servicing costs rise, but rising costs lower the amount of debt that can be carried. This is also why some financial institutions have already forecast higher mortgage rates. They aren’t even expecting rate hikes yet.
Borrowers Can Still Get Into Trouble
Too much debt can turn into a bad thing, as the capacity to borrow becomes smaller and smaller. BMO warns if lenders doubt a borrower’s capacity to repay, their access may be throttled. “Borrowers can still find a way into trouble,” warns the economist.
The recovery can leave borrowers vulnerable and unable to respond to the next crisis. When credit becomes a weight on households or governments, sacrifices are made. “…even absent a major crisis, it may well be the case that ultra-low long-term yields are telling us something important about long-term growth prospects,” he said.
The bank warns growth prospects for Canada and the US might be getting a little closer to mature. Real GDP growth in Canada and the US are forecast to be in the range of 1.5% to 2.0%. If they’re unable to increase rates, it might be a sign the population is getting a little older. As demographics shift towards older and more costly-to-maintain populations, they slow in growth. The tax burden shifts to a smaller, and young group. Younger borrowers can only borrow so much, while carrying the tax burden.
Once countries slant towards an older population, economic growth slows dramatically. “We’ll just note that economies that are further down the demographic line have seen much more modest average growth over the past 20 years—the Euro Area has averaged just under 1% in that spell, while Japan has been just below 0.5%,” they warn.
Or in plain english, if rates fail to rise, Canada could be at the phase where it needs to eat its young to survive. It might be time to fatten them up with credit, and feast on their tax revenues.
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