Canada's Credit Cycle Has Never Been This Desynchronized From the United States

A rapid private debt binge is nearly over, Macquarie says.
Photographer: Ben Nelms/Bloomberg

Canada has entered the very late innings of its super-charged private sector credit cycle, one that has completely decoupled from that of its largest trading partner, according to Macquarie Analyst David Doyle.

"Canada’s private sector nonfinancial debt to GDP ratio (includes household debt and non-financial business debt) has skyrocketed since 2005, rising by over 60 percentage points," he wrote. "This is a greater magnitude of increase than occurred for the forty years prior (1965 to 2005)."

As a result of this prolonged binge, Canada's private sector non-financial debt-to-GDP exceeds the comparable U.S. ratio by its highest level on record:


In the wake of the credit crisis through 2015, the U.S. economy experienced a painful deleveraging, with the ratio of private sector debt-to-GDP falling by an average of 2 percentage points per year. Meanwhile, Canada's credit cycle kicked into overdrive, with private sector debt-to-GDP rising nearly 5 percentage points each year.

Doyle indicated that it was the smaller retreat in Canadian home prices and the continuation of the commodity supercycle the enabled the credit cycle in the Great White North to decouple so markedly from that of the world's largest economy.

"What I've been telling clients is that Canada came through the financial crisis looking relatively good not because of productivity-enhancing advancements or anything like that, but by going through this hyper-leveraging cycle," said Doyle in a telephone interview.

While credit growth is poised to serve as a continued tailwind to activity south of the border, the analyst expects that Canada's credit frenzy will soon be over.

He suggested that the confluence of a surge in young, heavily-indebted households (eerily similar to the pre-crisis U.S.); ripple effects on employment from lower oil prices; and an increase in banks' funding costs due to global financial volatility and liftoff from the U.S. Fed—which have been passed along to households, and in particular, businesses—is likely to substantially slow the growth of Canadian private debt relative to GDP

In 2015, the Canadian economy was highly reliant on interest-rate sensitive segments for growth. Through November, more than half of the growth in the services side of the economy was attributable to the expansion of the real estate sub-sector.

It's hard to think of two economies that are more intertwined than Canada and the United States. Of the 120 instances since 1983 in which U.S. quarterly growth was positive, the Canadian economy also expanded 92.5 percent of the time. Two of these divergences occurred during the first half of 2015, and another two in 1986—the last supply-side fueled crash in oil prices.

Desynchronized credit cycles threaten to facilitate a further divorce in real activity between the two nations.

A best-case scenario for Canada would see the nation muddle through with a few years of sluggish growth, judged Doyle. Fiscal stimulus, a modest pick-up in non-energy goods exports, and growth in the export-oriented segments of the services sector could provide significant offset to the deterioration in credit-sensitive sectors that the analyst sees in the offing.

"We do see a path out, I don't know if I'd call it a beautiful one, but Canada doesn't have to look like the U.S. in 2008-2009," said Doyle.