Economics Newsletter – Week of May 17 2021

Written By: Amit Shteyer & Peter Robertson

Canada’s Economy at a Glance

Economics Society News, Events, and Articles 


Interested in investing? We are hosting an event with CFEE about investing basics! Register here. 

Release of the 2021 Financial System review by the Bank of Canada

Six key areas of vulnerability in the economy and financial system have been identified. These can lead to certain risks and can impair Canada’s financial system in the long term. Check out the full report here.

Vulnerability 1: Elevated levels of household indebtedness

  • This has built up over the past two years as many Canadian households accumulated high debt relative to the income they receive 
  • There has been an increase in mortgages with high loan-to-income (LTI) ratios 
  • The quality of mortgage borrowing has worsened since COVID-19 began 
    • LTI above 450 percent: these are mortgages that are higher than usual, borrowing amount is over 4.5 times higher than households’ gross income
  • Households with high loan-to-value (LTV) are mostly those that get high LTI mortgages
  • These high LTI and high LTV ratio borrowers are associated with great risk of failing to pay monthly payments 

Vulnerability 2: Imbalances in the housing market 

  • There is strong demand relative to supply and rising prices in the housing market
  • House prices are rising much faster than income – causing for increased leverage 
  • There is a misalignment between house prices and fundamentals, which may lead to future price corrections 
  • There has been a lot of activity in the housing market during the pandemic 
    • National residential resales reached close to a record high in April 2021
    • Inventory of existing homes for sale hit a record low 

Vulnerability 3: Fragile corporate debt funding from certain markets 

  • Businesses that have low credit ratings don’t have many financing options
  • As a result, these businesses issue high-yield corporate bonds or secure a leveraged loan
    • This makes them vulnerable to changes in investor behaviour 
    • This can lead to higher financing costs or reduced access to more financing
  • Since investors have a higher risk tolerance, the demand for high-yield assets increased
    • This makes the high-yield markets more attractive for low-rated businesses
  • When the risk free interest rate goes back to regular levels, this demand could diminish which could lead to a need for repricing of existing assets 
    • This could make rolling over existing debt and issuing new bonds a lot more expensive

Vulnerability 4: High potential demand for market liquidity relative to supply capacity

  • Current structure of fixed-income markets is not keeping up with the growth in potential demand for fixed-income market liquidity
  • The main reason for this is the asset management industry’s rapid growth which has resulted in a higher percentage of credit risk being held outside of the banking sector
  • Asset management industry has grown from $2.4 trillion in assets in 2008 to $5.7 trillion in 2020 mainly due to
    • Lower interest rates
    • Financial innovations
    • Demographic changes
    • Stricter banking regulations 
  • Changes in the portfolio’s of asset managers (increased real estate, infrastructure, and private equity holdings) has led to a higher dependance on liquidity 

Vulnerability 5: Cyber threats

  • Cyber attacks on financial institutions or infrastructure could lead to system-wide disruptions
  • The pandemic has accelerated digital transformation which also lead to increased “entry points” for cybercriminals
  • The financial industry is aware of potential cyber threats and has continued to invest in cyber defence

Vulnerability 6: Mispricing of assets exposed to climate-related risks

  • Climate related risks may not be priced into assets exposed to them
  • The future effects of climate change could lead to significant financial damage
  • An acceleration in the shift towards a low-carbon economy could cause a rapid revaluation of assets

News and Noteworthy

Canada’s annual inflation rate hits 3.4%, highest level in nearly a decade
New CPI data released by Statistics Canada on Wednesday revealed higher than expected inflation, reporting a 3.4% increase on a YOY basis compared to an expected 3.1%. This is the third month in a row that CPI has grown at a pandemic-era record, and the highest rise seen since May of 2011. Read more.

Bitcoin, other cryptocurrencies plunge after China announces ban
A ban on institutions providing cryptocurrency services by China sparked a massive slide across cryptocurrencies early this week. The market cap of the crypto sector fell nearly $1 trillion US at one point on Wednesday alone. Subsequently treasury yields fell as investors sought safety. The huge selloff through the midst of inflation worries puts its viability as an inflation hedge into question according to analysts. Read more.

Canadian dollar weakens by most in four weeks as commodities slide
A commodity slide on Wednesday prompted the Canadian dollar’s worst performance in a month. Massive rises in commodity prices have led to a strong dollar recently. Over the past 3 months the CAD/USD rate has increased by over 4.5%. In that same period of time the GSCI commodity index has increased by 6.6%. Read more.

Growing mortgage debt making Canada’s economy vulnerable, central bank says
Despite the fall in the level of consumer debt since early 2020, the rise in mortgage debt has more than offset that decrease. The high amount of household debt and the imbalances in the housing market have caused the Canadian economy to become a lot more vulnerable to economic shocks. Read more.

Who knew? Toronto the Boring is now North America’s top financial centre, next to New York
Toronto, Canada’s biggest city, has become North America’s second most important banking centre after New York. The city has been opening more financial positions, such as portfolio managers and bankers, than any other North American city. Read more. 

Posthaste: Look beyond the lockdowns — the Canadian economy is poised for a fulsome recovery
Currently, almost 45% of Canadians have at least one dose of the COVID-19 vaccine. This makes Canada the 24th most vaccinated jurisdiction by population. Forecasts for the Canadian economy’s state in late 2021 have been rising. Will we have a normal summer? Read More.

Recommended Read 

The Age of Turbulence; adventures in a new world
By Alan Greenspan

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