Macklem says mortgage arrears could surpass 2008 levels if US trade conflict drags on for years
The Bank of Canada has warned that a prolonged trade war, triggered by the United States, poses the most serious risk to the Canadian economy and could threaten the country’s financial stability.
According to the BNN Bloomberg, Governor Tiff Macklem stated at a news conference in Ottawa that “we now face a new threat.”
As per the bank’s Financial Stability Report, Canadian households started the year with less debt relative to their income than a year earlier, and business insolvency filings had dropped significantly.
However, the report also emphasized that the trade war has reversed some of these positive trends.
“The trade war poses new risks. So even if things were moving in the right direction, it’s a really good time to get prepared for possible turbulence ahead,” Macklem said.
According to the bank, the future path of tariffs remains uncertain, but a scenario where they remain elevated for several years could cause a rise in mortgage defaults not seen in decades.
“A long-lasting trade war poses the greatest threat to the Canadian economy,” Macklem said.
In a more pessimistic—but not forecasted—scenario, the bank projected mortgage arrears could rise above 0.5 percent. That level would surpass the 2008–09 global financial crisis but remain below the 1990s peak of over 0.6 percent.
The bank also noted that the scale and reach of government supports could affect the outcome, though it is not yet clear how extensive these supports would be.
As reported by Reuters, the bank highlighted that financial institutions, especially banks, could face losses if the trade conflict continues.
“If credit losses occur on a large enough scale, banks could cut back on lending in response. Struggling households and businesses would have less access to credit to get through tough times. This cycle could exacerbate the economic downturn,” the bank stated.
According to the same report, some households—especially those without mortgages—are already showing signs of stress.
The bank reported that credit card and auto loan payments more than 60 days overdue have surpassed pre-pandemic levels and have exceeded historical averages for non-mortgage households.
In contrast, households with mortgages still show payment arrears below historic averages.
The bank also warned of financial stability risks arising from hedge funds, which have increased their exposure to Government of Canada bonds.
In some cases, hedge funds purchased nearly half of all bonds issued at auction.
Since these investments are highly leveraged, the bank said they could withdraw from the market under stress, potentially disrupting bond markets.
According to the bank, Canadian banks currently remain well-positioned to absorb potential losses, supported by higher capital buffers and provisions for credit losses.
Nevertheless, the bank expressed concern that continued uncertainty could lead to overconfidence if vigilance is not maintained.
“We want to make sure that there is a level of vigilance, that there isn’t overconfidence that everything is going to work out, and that the financial system is prepared for turbulence,” said Macklem.
A separate stress-test scenario from the International Monetary Fund (IMF), included in the bank’s report, assessed a more extreme situation.
According to the IMF analysis, a prolonged recession lasting seven quarters could result in GDP falling by 5.1 percent, unemployment peaking at 9.2 percent, housing prices dropping 26 percent, and equity markets declining by 36 percent from peak to trough.
The bank’s own risk scenario assumes a four-quarter recession, similar to those seen in 1990–91 and 2008–09.
As per the bank, recent signs of easing trade tensions—such as news of trade progress between the US and the UK—suggest a potential shift, though Macklem cautioned that it is “still early days.”
He added, “I expect there will be some permanent impacts. It does feel like trust has been broken to a certain degree.”
Despite the current volatility, the bank said household and business financial conditions had improved earlier in the year.
As reported by BNN Bloomberg, households renewing mortgages in 2024 or 2025 are expected to face smaller payment shocks due to the sharp drop in interest rates.
Many homeowners have also benefited from income growth and increased property values.
According to the bank, non-financial businesses also remain in relatively good health. The spike in insolvencies following the end of pandemic-era government supports was short-lived.
Prior to the surge in market volatility at the beginning of April, businesses saw strong debt issuance and low financing costs.
However, the bank cautioned that businesses with pre-existing vulnerabilities—such as high leverage, low cash reserves, or weak profitability—could fall behind on debt payments if economic conditions worsen.
The bank stated that loans to households and businesses in trade-sensitive sectors or regions account for about 15 percent of Canadian bank assets.
Nonetheless, the bank warned that the economic fallout from a trade war could have broader repercussions across other sectors and regions.
