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Bank of Canada warns high household debt and elevated home prices pose top risks to economy

The Bank of Canada has warned that household vulnerabilities have worsened over the past year and could lead to stress in the financial system as people struggle to service their debts.

In its latest Financial System Review, the central bank identified high levels of household debt and elevated home prices as the top two vulnerabilities, saying they could even result in a financial crisis.

The cost of borrowing has spiked over the past few months and is expected to continue on that path as the Bank of Canada aggressively raises interest rates to combat high inflation.

“Our primary focus is getting inflation back to target. Monetary policy is not housing policy,” central bank governor Tiff Macklem said at a news conference.

Higher interest rates have already slowed real estate activity, with sales declining nationwide and home prices falling in some of the country’s hottest markets. Several private-sector economists have forecast double-digit declines in prices this year, but the central bank said it was too soon to say whether this was the start of a substantial correction.

At the press conference, Mr. Macklem repeatedly stressed that the central bank’s priority was to get inflation back to normal even if that meant a cooldown in the housing market. The bank has raised interest rates at three consecutive rate decisions and has said that intends to keep pushing borrowing costs higher.

“Some moderation in housing would be healthy,” said Mr. Macklem. He did not say how much moderation would be healthy. But in some places like Halton, an affluent region just west of the city of Toronto, the typical home price has dropped 13 per cent over the past three months.

The bank listed several worrisome trends that it has observed over the course of the latest real estate boom: households have increasingly stretched themselves financially to purchase property; home buyers have made smaller down payments relative to the purchase price in recent quarters; and investors have increasingly leveraged the homes they already own to buy new properties.

The high amounts of household debt could eventually become problematic for the financial system as central banks around the world raise interest rates. The global economy could soon start to slow or slip into a recession. That could lead to job losses and make it harder for mortgage holders to make their loan payments.

If home prices drop, that could further restrain homeowners’ ability to use the equity in their homes. Homeowners may be forced to reduce their spending and/or sell their properties.

“If the shock is large enough to cause many households to be in this situation, the size of the impact could create a negative feedback loop between the real economy and the financial system,” the report said. “The likelihood of this risk materializing and its impact on the economy are greater today than in the past.”

The central bank is primarily concerned about the highly indebted Canadians who took out mortgages over the past two years. Borrowers with a loan-to-income ratio above 450 per cent account for over 25 per cent of all mortgage holders – a record high.

Central bank economists have calculated that those borrowers would see a significant jump in mortgage payments at renewal time. If a borrower took out a variable-rate mortgage in 2020 or 2021, they would see a median increase of $1,000 in their monthly payments in 2025 or 2026, the report said.

Despite the growing risks, the central bank said commercial banks remain well-positioned to weather an economic downturn or shock coming from the housing market.

In the event of a “severe and prolonged recession,” Canadian banks would experience a significant hit to their capital buffers but would likely be able to continue lending to businesses and households, the bank said. This is supported by sound mortgage underwriting practices, solid capital ratios and a “robust capacity to generate revenues even in times of stress.”

The Bank of Canada offered a relatively upbeat assessment of corporate balance sheets. The ratio of debt to assets for non-financial companies has declined continuously since its peak in the second quarter or 2020. Meanwhile, the ratio of cash to debt has reached an all-time high.

“This improvement is due in part to the favourable impact that rising commodity prices are having on corporate balance sheets in the resource sector – a sector where firms have historically been more financially vulnerable,” the bank noted.

Companies that use bond markets to raise money will face higher borrowing costs as interest rates rise. But the central bank noted that most outstanding bonds are not set to mature in the next five years.

Still, companies could face challenges servicing their debts if the economy moves into recession, the bank said: “The direct impact of higher interest rates on the financing costs of most publicly listed firms will likely be small but could be problematic if higher rates are accompanied by a shock to firms’ revenues.”

The Financial System Review noted a range of other risks that appear to be growing. Russia’s invasion of Ukraine has increased the chance of a state-sponsored cyberattack against Canadian banks, the central bank said.

Meanwhile, financial stability concerns related to climate change remain a pressing issue. The worry is that asset prices and company valuations do not properly account for risks related to a transition to a lower-carbon economy.

The bank also expanded its analysis of cryptocurrencies. It reiterated its view that cryptocurrencies are “not yet of systemic importance” to the Canadian financial system. Although it did note that interest in the asset class is growing rapidly and expanding from retail investors to institutional investors.

In 2021, about 13 per cent of Canadians owned bitcoin, up from 5 per cent in 2020. The median holding was about $500.

The bank’s principal concern is the lack of regulation in the sector. Many cryptocurrency companies function like traditional financial institutions but with far less oversight.

European Central Bank confirms July rate hike plans, raises inflation projections significantly

• Annual consumer price inflation across the 19-member euro area hit a fresh record high of 8.1% in May.
• Following its latest monetary policy meeting, the Governing Council announced it intends to raise its key interest rates by 25 basis points at its July meeting.
• Policymakers face the challenge of reining in inflation without compounding the economic slowdown resulting from the war in Ukraine and the associated sanctions.

https://www.cnbc.com/2022/06/09/european-central-bank-confirms-july-rate-hike-plans-raises-inflation-projections.html

Oil prices face big volatility as spare capacity dries up

After more than a year of pressure from the United States and other top oil consuming countries, OPEC+ finally agreed to accelerate oil supply increases last week to tame runaway fuel prices and slow inflation.

But that will leave producers with very little spare capacity, and almost no room to compensate for a major supply outage.

Tight spare capacity is likely to keep oil prices volatile and sensitive to any disruptions in output, such as a big hit from a hurricane to Gulf of Mexico production during the Atlantic storm season, or a further fall in exports from sanctions-hit Russia.

The most conservative estimates forecast OPEC’s spare capacity dropping to below 1 million barrels per day (bpd) later this year, representing about 1% of global demand and barely one twentieth of U.S. demand.

Only a handful of OPEC producers, namely Saudi Arabia and the United Arab Emirates, have any meaningful spare capacity.

Consultancy Energy Aspects sees spare capacity within OPEC+ – a group comprising OPEC and allies led by Russia – at 1% of global demand of 102 million bpd by year-end, its lowest level since at least 2012 when it began its assessments.

Spare capacity dipped to similar levels when key OPEC producers briefly pushed output above sustainable levels during the April 2020 price war, Energy Aspects’ head of geopolitics Richard Bronze said.

Barclays says dwindling spare capacity will be a key driver for heightened volatility in the oil market.

The bank raised its oil price forecast for Brent by $11 a barrel for 2022 and $23 a barrel for 2023.

“Saudi Arabia will be producing (about) 11 million bpd by the end of summer, and real spare capacity globally which can be brought online fairly quickly will be standing at just 1.5% of global demand,” the bank said.

Saudi Arabia says it can produce about 12 million bpd, but this level has never been tested. The kingdom has never previously pumped at the 11 million bpd mark for a sustained period.

On June 2, OPEC+ agreed to speed up steady monthly output increases as it slowly reversed the deep production cuts made at the height of the COVID-19 pandemic. OPEC+ has set itself a target to lift output by 648,000 bpd per month in July and August.

The group is unlikely to pump as much as it is targeting. Many members of the OPEC+ alliance have been grappling for years with capacity constraints due to underinvestment. JPMorgan expects OPEC+ to add 160,000 bpd in July and 170,000 bpd in August. Russia is also well below its target as sanctions following its invasion of Ukraine on Feb. 24 make exports difficult. Russian oil output declined by about 1 million bpd from pre-invasion levels in April, according to the International Energy Agency (IEA), but some analysts forecast that decline to deepen to least 1.5 million bpd later this year due to sanctions.

In April, OPEC+ produced 2.6 million bpd below targets, mainly due to falling Russian output.

“Capacity matters much more than OPEC+ monthly baselines, and we are nearing the threshold wherein small temporary supply disruption could cause acute asymmetric price risks to the upside,” MUFG said.

Saudi Aramco is investing heavily in capacity expansion, but it is not expected to be until at least the end of 2026 that it rises to more than 13 million bpd.

The UAE, which has production capacity of just above 4 million bpd, is targeting adding another 1 million bpd by 2030.

Other cushions for the oil markets are also exhibiting tightness. Commercial oil inventories in the developed world are about 300 million barrels below the 5-year average.

A coordinated release of oil from strategic reserves by the IEA in recent months may have provided temporary relief and offset the fall of Russian volumes, but those barrels will have to be replenished eventually.

Going forward, some analysts say that a challenge to oil’s bull run could come from consumers using less oil as high prices hit their finances.

“Bullishness for crude prices has hit some exhaustion as the energy market has mostly priced in the EU’s ban on most Russian oil imports, a modest boost by OPEC+, and elevated prices that will surely lead to some demand destruction over the coming months,” OANDA analyst Edward Moya said.

Conservatives, NDP push Liberal government to take more action against inflation

Federal opposition parties are pressing the government to do more to curb inflation before Parliament rises for the summer, although there is considerable disagreement on whether to tackle cost-of-living challenges by cutting taxes or by raising them and redistributing the revenue.

On Tuesday, the Conservatives used their final opposition day before the summer recess to introduce a motion calling on the government to freeze the goods and services tax on gasoline and diesel, suspend the carbon tax and lift tariffs on fertilizer imports, among other requests.

“People don’t need a cheque from the government. They need taxes cut,” Interim Conservative Leader Candice Bergen said in a Tuesday news conference before debate on the motion. “The best way to provide relief for Canadians is to cut their taxes, not promise them a cheque might come in the mail.”

The motion was scheduled for a vote late on Tuesday. The Liberals and the NDP, which when voting together have a majority in the Commons, spoke against the Conservative proposal.

Meanwhile, the NDP reiterated its own proposal to tackle affordability by taxing “excess profits” large companies have earned during the COVID-19 pandemic and redistributing the revenue to low-income families through increases to the GST credit and Canada child benefit.

The sharp rise in consumer prices, particularly for essentials such as food, gasoline and housing, has become a major political issue. Opposition parties have spent much of the past two Parliamentary sessions needling the government about inflation, which hit a three-decade-high annual rate of 6.8 per cent in April.

Lumber prices are falling, but don’t expect prepandemic level markdowns for your next DIY project

So far, opposition proposals to deal with it have made little headway.

The Liberals have shrugged off efforts to pin soaring prices on them, arguing that inflation is a global phenomenon caused by pandemic-related disruptions in supply chains and, more recently, a commodity price shock due to Russia’s invasion of Ukraine.

Liberal ministers have also pointed to initiatives such as subsidized child care and an expansion of the Canada Workers Benefit, which goes to low-income earners, to argue that the government has been pro-active on cost-of-living issues.

At the same time, the government has taken fewer steps to tackle price increases or offset rising costs than those of other advanced economies.

In March, U.S. President Joe Biden ordered the release of strategic oil reserves. That is putting an additional million barrels of oil on the market every day for six months.

Mr. Biden has said getting inflation under control is his economic priority, and over the past few months he has emphasized the importance of reducing the size of the U.S. federal government deficit as a means to do it. The Democratic administration is under considerable pressure to show it is serious about inflation control before the mid-term Congressional elections in the fall.

Germany’s ruling coalition announced a €16-billion ($21.5-billion) inflation-relief package in March that includes measures such as cutting the tax on gasoline for three months by around 30 Euro cents per litre.

European countries face an acute inflation shock, as sanctions against Russia have affected much of their oil and gas supply.

When asked in question period on Tuesday why the Canadian government was not doing more to address rising fuel prices, Natural Resources Minister Jonathan Wilkinson said the government was working with allies to stabilize international energy markets.

“In this regard, we have committed to increasing oil and gas production by 300,000 barrels per day by the end of the year. At home, we’ve instructed the Competition Bureau to ensure there is no collusion around gas pricing,” Mr. Wilkinson said.

The United Kingdom’s Conservative government has introduced a “windfall tax” on energy company profits similar to what the NDP has proposed.

Starting at the end of May, energy companies operating in Britain face an additional 25-per-cent levy on earnings – although there are exemptions to encourage things such as increased investment. The U.K. government plans to direct these funds toward initiatives aimed at alleviating cost-of-living challenges.

Canada’s Liberal government raised taxes on excess banking and insurance company profits in its April budget. This included a 1.5-per-cent bump to the corporate income tax on profits over $100-million, as well as a one-time tax of 15 per cent on bank and insurance company income above $1-billion for 2021.

NDP Leader Jagmeet Singh said on Tuesday that the government should expand on this initiative by taxing other large companies experiencing windfall profits, “particularly the big-box stores and oil and gas companies.”

It is the responsibility of government to say, “If you’re making excess profits off the backs of people in a difficult time when people can’t afford to eat, then you have to start paying your fair share,” Mr. Singh said in a news conference.

The main responsibility for reining in inflation lies with the Bank of Canada, which has begun aggressively raising interest rates to try to slow the economy and bring demand and supply back in line. The central bank has increased its policy interest rate at three consecutive rate decision meetings, to 1.5 per cent, and said that it may need to push the benchmark rate to 3 per cent or higher.

Before the Bell: June 6

Equities

Wall Street futures were higher early Monday after modest losses last week. European markets gained in morning trading. TSX futures were also up alongside positive global sentiment and advancing crude prices.

Futures tied to the three key U.S. indexes were all in positive territory in the early premarket period with S&P and Nasdaq futures advancing by more than 1 per cent. All three posted another losing week last week with the Nasdaq and the S&P recording eight straight weeks of losses. The S&P/TSX Composite Index finished out the Friday session down 1.15 per cent. The index still managed its third straight weekly advance, adding 0.2 per cent on the week.

This week, Wall Street will be awaiting the latest U.S. inflation figures on Friday. Those come ahead of next week’s Federal Reserve meeting and another expected rate increase.

“As we look ahead to this week’s U.S. CPI numbers for May, the main worry for investors is that in their increasing urgency to contain upside risk in inflation, central banks tighten monetary policy too quickly and tip the global economy into recession,” Michael Hewson, chief market analyst with CMC Markets U.K., said.

“It is becoming increasingly obvious from the tone of a number of Fed policymakers that a pause in the U.S. rate hiking cycle appears unlikely at the moment,” he said.

In Canada, investors will get April international trade numbers on Tuesday followed by May jobs numbers at the end of the week.

“Friday’s May employment report is expected to show a gain of 15,000 jobs, which would match April’s increase,” Alvin Tan, Asia FX strategist with RBC, said.

“Employment growth has slowed dramatically in recent months as strong labour demand is tempered by a reduction in the number of workers available for hire as evidenced by April’s unemployment rate of 5.2 per cent – the lowest since at least 1976.”

On the corporate side, Rogers Communications Inc. filed its response to the Competition Bureau’s attempt to block its merger with Shaw Communications on Friday after the close of markets. The Globe’s Alexandra Posadzki reports that Rogers says Canada’s Commissioner of Competition has taken an “unreasonable” position and has failed to demonstrate that Rogers’ $26-billion takeover attempt of Shaw Communications would substantially reduce competition in the wireless market.

Overseas, the pan-European STOXX 600 was up 0.92 per cent in morning trading. Britain’s FTSE 100 gained 1.26 per cent. Germany’s DAX and France’s CAC 40 advanced 1.06 per cent and 1.17 per cent, respectively.

In Asia, Japan’s Nikkei finished 0.56-per-cent higher. Hong Kong’s Hang Seng jumped 2.71 per cent on gains in tech shares.

Commodities

Crude prices were higher in early going after Saudi Arabia hiked costs for July crude sales despite an increase in OPEC+ production.

The day range on Brent is US$119.63 to US$121.95. The range on West Texas Intermediate is US$118.96 to US$121. Brent gained 1.8 per cent on Friday while WTI rose 1.7 per cent.

On Sunday, Saudi state oil producer Aramco said Saudi Arabia was raising the July official selling price for its Arab light crude to Asia by US$2.10 from June to a US$6.50 premium versus the average of the Oman and Dubai benchmarks, according to Reuters.

That move came even as OPEC+ members agreed last week to increase output in July and August by 648,000 barrels per day, or 50 per cent more than planned.

However, Stephen Innes, managing partner at SPI Asset management, said the initial bounce on the Saudi price hike was offset somewhat by reports that the U.S. may allow more Iranian oil onto global markets to lean against prices ahead of mid-term elections in November.

In other commodities, gold prices edged higher helped by a modest pullback in the U.S. dollar.

Spot gold was up 0.1 per cent at US$1,851.98 per ounce by early Monday morning, while U.S. gold futures rose 0.2 per cent to US$1,854.60.

Currencies

The Canadian dollar was higher, supported by positive risk sentiment and gains in crude prices, while its U.S. counterpart saw slight declines against a group of world currencies.

The day range on the loonie is 79.35 US cents to 79.64 US cents.

Traders will get Canadian trade numbers on Tuesday followed by the monthly labour force survey on Friday.

On world markets, the U.S. dollar index, which weighs the greenback against a group of currencies, fell 0.1 per cent early Monday morning to 101.99, near its lowest since late April, according to figures from Reuters.

The euro, meanwhile, was up 0.2 per cent against the greenback at US$1.074 ahead of the ECB rate decision later in the week. The European Central Bank isn’t expected to start raising rates until later in the summer.

The yen was trading at 130.73 just off its two-decade low of 131.35 against the U.S. dollar, and at 140.3 close to its seven-year low of 140.36 versus the euro.

The Australian dollar was steady at US$0.7218 on Monday ahead of a central bank policy decision later in the week.

In bonds, the yield on the U.S. 10-year note was little changed at 2.957 per cent in the predawn period.

More company news

Starbucks Corp said Howard Schultz would remain the coffee chain’s interim chief executive officer until the end of the first quarter next year, as it looks for a permanent successor.

Economic news

China PMI and foreign reserves

Asia-Pacific stocks decline; private survey on Chinese services activity for May ahead

• Asia-Pacific stocks declined in Monday morning trade.
• China’s Caixin Services Purchasing Managers’ Index is set to be out at 9:45 a.m. HK/SIN on Monday.
• Markets in South Korea are closed on Monday for a holiday.

https://www.cnbc.com/2022/06/06/asia-markets-caixin-services-pmi-china-economy-currencies-oil.html

Economic Calendar: June 6

Monday June 6

China PMI and foreign reserves

==

Tuesday June 7

Japan household spending

Germany factory orders

(8:30 a.m. ET) Canada’s merchandise trade balance for April.

(8:30 a.m. ET) U.S. goods and services trade deficit (and revisions) for April.

(10 a.m. ET) Canadian Ivey PMI for May.

(3 p.m. ET) U.S. consumer credit for April.

==

Wednesday June 8

China aggregate yuan financing, new yuan loans, money supply and trade surplus

Japan GDP, current account surplus and bank lending

Euro zone GDP

Germany industrial production

(10 a.m. ET) U.S. wholesale inventories for April.

Earnings include: Dollarama Inc.; Transcontinental Inc.

==

Thursday June 9

Japan machine tool orders

ECB Monetary Policy Meeting

(8:30 a.m. ET) U.S. initial jobless claims for week of June 4. Estimate is 210,000, up 10,000 from the previous week.

(12 p.m. ET) U.S. flow of funds for Q1.

(10:30 a.m. ET) Bank of Canada Financial Systems Review with press conference to follow.

Earnings include: Enghouse Systems Ltd.; Nio Inc.; Saputo Inc.

===

Friday June 10

China CPI and PPI

(8:30 a.m. ET) Canadian employment for May. The Street is forecasting an increase of 0.1 per cent (or 10,000 jobs) from April with the unemployment rate remaining 5.2 per cent.

(8:30 a.m. ET) U.S. CPI for May. The consensus estimate is a rise of 0.7 per cent from April and 8.2 per cent year-over-year.

(10 a.m. ET) U.S. quarterly services survey for Q1.

(10 a.m. ET) U.S. University of Michigan Consumer Sentiment for June.

Norway oil and gas workers threaten strike, some crude output at risk

At least 647 Norwegian oil workers plan to strike from June 12 if state-brokered wage mediation fails, labour unions said on Friday, putting some crude output at risk of shutdown although gas may not be affected.

Workers are seeking above-inflation pay increases and other changes to their contracts but have not released details of their demands.

Members of the Industri Energi and Lederne unions plan strike action at 10 permanent offshore installations, including the Njord A, Valhall, Gudrun and several Oseberg platforms, as well as three mobile service units, the unions said.

Lederne would initially involve 74 mostly senior offshore workers in a strike, likely hitting oil production at the Equinor-operated Gudrun, Oseberg South and Oseberg East platforms, the union said.

Gas production should remain unaffected however, Lederne chief Audun Ingvartsen told Reuters.

“We will try to avoid affecting gas production as we are mindful about the situation with gas supplies in Europe,” he said.

“I hope we can find the best solution both for Norway and the oil companies, and at the same time give something back to the workers. I hope we can avoid a strike.”

Lederne is negotiating on behalf of some 1,300 union members.

Equinor did not immediately respond to a request for comment.

Gudrun produced 45,700 barrels of oil equivalent per day (boed) in 2021, Oseberg East 5,600 boed and Oseberg South 32,000 boed, official data shows, around two percent of Norway’s overall daily oil and gas output.

The Industri Energi union meanwhile said it would initially seek to avoid hitting production altogether, even as 573 of its members could go on strike.

“The first instance of a potential strike would only involve a limited number of members, but we can escalate if necessary,” Industri Energi’s chief negotiator Lill-Heidi Bakkerud said.

Industri Energi is Norway’s biggest oil and gas union, negotiating on behalf of some 4,300 members.

The Safe labour union, which will also take part in the June 10-11 mediation, has yet to outline its response.

US economy sees solid job growth in May as payrolls jump by 390,000

The U.S. economy continued to see healthy job growth in May, indicating the labor market is still strong despite growing fears of a recession amid sky-high inflation and an increasingly aggressive Federal Reserve. 

Employers added 390,000 jobs in May, the Labor Department said in its monthly payroll report released Friday, beating the 328,000 jobs forecast by Refinitiv economists. The unemployment rate, meanwhile, held steady at 3.6%, the lowest level since February 2020.

Job gains were broad-based, with the biggest increases in the pandemic-battered leisure and hospitality industry (84,000), professional and business services (75,000) and transportation and warehousing (47,000).https://flo.uri.sh/visualisation/9820374/embed

“This does not look like a labor market about to tip into recession,” said Daniel Zhao, senior economist at jobs review website Glassdoor. “Job gains were healthier than expected and the labor force participation rate ticked up. Despite concerns about a slowdown and even a recession, the labor market’s fundamentals look healthy.”

Businesses are eager to onboard new employees and are raising wages in order to attract workers as they confront a labor shortage. There were roughly 11.4 million open jobs at the end of April – near a record high – while the number of Americans quitting their job is also well-above pre-pandemic levels.

Millions of workers are seeing the largest pay gains in years, as companies compete with one another for a limited number of employees. Earnings rose 5.2% in May from the previous year, much higher than the pre-pandemic average of 3%. There are signs that growth could be moderating though, with earnings climbing just 0.3% on a monthly basis, slower than Refinitiv expected.

https://www.foxbusiness.com/economy/us-economy-sees-healthy-job-creation-may-payrolls-grow