Canadian Debt Will Be Cheap Going Forward, But Not THIS Cheap: BMO

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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  • Kathy 3 years ago

    Few understand this. Canada is spending $2 billion per week to provide a bigger discount on mortgage rates than they should be.

    • David Chan 3 years ago

      Yup. That balance sheet expansion is also excessive, producing inflation. Every person being paid a salary instead of equity like public company executives are seeing their buying power reduced to subsidize this bubble.

  • Rob Turner 3 years ago

    The only people dumb enough to lend money out this cheap are taxpayers. Either the Bank of Canada tries to own everything, or people have to start paying inflation levels of debt.

  • Yusef 3 years ago

    Few understand some governments will spend as much as they can, knowing it will make them look like rockstars when the economy is “booming.”

    The boom isn’t real, they’re borrowing future growth which has to be paid back with interest. Ultimately the growth ends up slower, since interest is also paid back.

    Then when an adult is elected that isn’t trying to just keep appearances up, people wonder why things can’t grow as fast.

    • Doomcouver 3 years ago

      I have a theory that’s why Trudeau called an early election. He knows he can’t keep CRB and the wage subsidies running much longer, but taking them away is going to plunge us into recession immediately. Trying to get re-elected during a nasty recession is pretty much impossible, thus now was politically the best time to try and get a new mandate in an election before SHTF.

    • Joe B 3 years ago

      Agreed. The Feds are essentially robbing Peter to pay Paul. Hopefully Peter shows up to the polls next week.

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