I firmly believe there’s one chart that represents the most important data relationship for the domestic economy in 2024. It measures the extent to which mortgage debt is strangling Canadian economic growth.
This chart right now isn’t sending a definitive signal of what’s to come. But the backdrop to this data relationship couldn’t be more alarming: The ratio of total household debt to disposable income stands near record highs at 182 per cent.
The red line on the chart shows the year-over-year percentage change in the debt service ratio (the proportion of disposable income necessary to make monthly service payments on debt), and the blue line is the year-over-year percentage change in retail sales.
The premise in comparing these series is that if Canadian households are struggling with the effects of higher borrowing costs and mortgage renewals, the stress will first be apparent in retail sales data. Mortgage and credit card payments can’t be skipped, but overall spending can be curtailed to compensate.
The correlation between the debt service ratio and retail sales has been inconsistent at best over the past 30 years – extremely low from 1993 to 2008, and then significantly higher, but not excessive, in the post-financial-crisis, prepandemic era.
Things got a lot more interesting starting in September, 2022, with rising interest rates pushing the debt service ratio sharply higher while retail sales growth headed straight south. The data reached extremes during the first half of 2023. The 0.7 per cent year-over-year decline in retail sales was only exceeded during the financial crisis and early in the pandemic. The 9.7-per-cent jump in debt service costs registered in March, 2023, is the biggest increase in at least 30 years.
The divergence in the chart closed somewhat last September (the most recent debt-to disposable-income report available), with the debt ratio higher by a still-elevated 6.7 per cent and retail sales recovering to 2.7 per cent growth, year over year.
I’m not suggesting the recent data prove that debt payments are crowding out spending – not yet. As it stands, the chart shows a debt-to-disposable-income ratio that continues to trend higher, while retail sales growth remains well below the 20-year average of 4.5 per cent, year over year.
A healthy domestic job market and fading (if stubborn) inflation pressure should prevent a worst-case scenario of mortgage defaults, a deep recession and a collapse in consumption. Economic and investment risk will rise, on the other hand, if the two lines on the chart diverge.
Domestic gross domestic product growth has been anemic lately – Bank of Montreal strategist Benjamin Reitzes noted that the “Canadian economy is going nowhere” in a recent report. This provides an economic backdrop that is likely to pressure retail sales precisely when higher interest rates are making life more difficult for more households.
Investors should pay careful attention to both data series as 2024 progresses. If the divergence on the chart expands, investors should favour market sectors with higher foreign rather than domestic revenue.
Scott Barlow is a market strategist for The Globe and Mail
