At the start of the year I laid out a scenario where the North American economy would start the year with surprising resilience but then there would be divergence between the United States and Canada because of the differing mortgage markets.
To recap: In the US, 90% of borrowers have 30-year fixed rate mortgages, leave the consumer's largest source of debt immune from rate hikes. In Canada, a high portion of borrowers are on variable rate mortgages with the remainder on loans where rates reset every 5 years. Given extremely high home prices in Canada, high rates are hitting hard.
I believe that we're currently crossing the threshold where Canada's economy significantly underperforms the US, at least via consumer spending. We got strong evidence of that last week from Canadian Tire, which is a local Wal-Mart competitor that also has brands in clothing retail, party supplies and sporting goods.
The company withdrew its forecast and said discretionary spending was to blame:
“With 10 interest rate hikes in less than 18 months, and persistent inflation impacting the cost of living and leading to reduced savings cushions, Canadian consumers are experiencing increased financial strain and facing tougher spending decisions,” president and chief executive officer Greg Hicks said on a conference call to discuss the results. "As inflation continues to persist along with rate hikes, consumers are feeling the squeeze and finding themselves in a precarious financial position, which has driven a change in household spend."
Notably, the company also has a large credit card decision so it has some of the best data available.
"Our Essentials portfolio was up more than 6% in the quarter, and our discretionary portfolio was down more than 3%. This performance delta was evident for much of the quarter and accelerated in June. When combining our triangle membership data with external household data we use in our real estate modeling, we see that the discretionary softness is coming from more indebted households, most notably in Ontario and BC," Hicks said.
The two most-overstretched housing markets in Canada are in Ontario (Toronto) and BC (Vancouver).
The silver lining is that the company said that cost pressures were improving.
Some might argue the company is facing pressure from Amazon but I don't think it's a coincidence that demand suddenly fell in June, just as the Bank of Canada delivered another rate hike.
Moreover, Canadian mattress retailer Sleep Country also said this:
“We are reducing our forecasts for 2023 and 2024 to reflect (1) the profitability pressure stemming from new acquisitions, and (2) lower same-store-sales growth assumptions to reflect a softer demand dynamic in Canada for the remainder of 2023."
In FX, the Canadian dollar has been softening lately and it's important to note that the latest decline has come despite higher oil and gas prices. I think that -- and summer malaise -- has disguised some of the headwinds about to hit the loonie. I've long argued that the final Bank of Canada rate hike was a mistake and I don't think it will be long before they pivot to a clear neutral stance followed by a surprisingly quick turn to rate cuts.
With that, I see USD/CAD on track to 1.3950 or 1.4000 and I think it will be a wise move to buy ahead of any scheduled comments from Bank of Canada policymakers, who I expect will imminently announce a shift.
Importantly, I also expect consumers in Australia, New Zealand, the UK and parts of Europe to experience the same deterioration.
