EDITORIAL: Big government cut economic growth

Total public spending rose to 43.6% of Canada’s GDP in 2024 (from 37.4% in 2007), well above the cited optimal range of 26–30%. Public-sector employment climbed to 21.5% of workers in 2024 (from 19.2% in 2007), spending shares increased in nine of 10 provinces since 2007, and several provinces report government spending >50% of GDP (e.g., Nova Scotia 61.2%, New Brunswick 60.6%). The Fraser Institute warns this enlarged size of government is curtailing economic growth, with Canada posting the weakest real GDP per capita growth of any federal government over the past decade.

Analysis

The fiscal footprint now dominates supply-side dynamics in Canada: larger public-sector payrolls and persistent budgetary deficits are creating chronic upward pressure on domestic bond issuance and nominal yields, which will increasingly crowd out private investment in capital-intensive sectors. That crowding-out transmits through two channels — higher real borrowing costs for provinces and corporates, and stickier wage floors for labour-intensive private firms — compressing margins in retail, hospitality and regional construction over the next 6–24 months.

Regional divergence will be the market’s defining story: provinces that preserve private-sector-friendly policy frameworks and energy-export optionality should outgrow high-transfer, high-employment provinces where public pay and benefits sustain consumption but not productivity. This divergence creates an idiosyncratic credit-risk premium at the provincial level that is not yet fully reflected in liquid markets, so relative-value trades across geographies look attractive.

Macro reflexes matter: a sustained shift toward heavier fiscal spending increases the probability of either higher long-term yields or taxpayer-facing retrenchment (higher taxes/fees); both are negative for cyclical and credit-sensitive equities but supportive for short-duration, high-coupon assets and FX carry trades in safe-haven USD. Watch political calendars — provincial elections or federal budget cycles are likely catalysts to reprice spreads within quarters.

Consensus underestimates the persistence and second-order effects of public-sector wage stickiness; fiscal rollbacks are politically costly and unlikely to fully offset bond-market pressure quickly. That argues for trades that monetize yield and regional-credit dispersion rather than binary macro calls that assume rapid structural reform.

Key Decisions for Investors

• Buy USD/CAD 6–12m calls (or enter a USD/CAD forward) sized for a 3–5% move — R/R: pay ~1–2% premium to capture CAD downside if Canadian yields reprice wider or growth lags; stop if CAD strengthens >2% in 4 weeks.
• Relative-value equity pair: long CNQ (Canadian Natural Resources) + SU (Suncor) vs short RY (Royal Bank of Canada) 1:1 market value — 3–12 month horizon; target 20–30% relative outperformance. Rationale: energy exposure to higher private-sector activity and migration vs banks’ sensitivity to provincial credit and mortgage stress; stop-loss if oil falls >15% or banks outperform by >10%.
• Sell Canada 10Y futures (or buy long-CAD yield exposure) — size for a 25–50bp widening over 6–12 months. R/R: each 25bp move yields ~0.5–1.0% P/L on a 10Y-notional; hedge with duration in US Treasuries if global risk-on accelerates. Cut if Canadian 10Y rallies >15bps from entry.
• Buy 6–12m put options on large Canadian banks (e.g., RY or TD) ~15% OTM to hedge regional-credit shock — limited-premium downside insurance that pays off on provincial fiscal stress or a retrenchment-driven consumer slowdown; target asymmetric payoff with defined loss = option premium.
• If liquid, allocate a small tactical sleeve to provincial CDS protection (5y) on high-spend Atlantic provinces — aim for 200–400bp spread widening scenarios over 12–36 months; keep exposure size modest due to liquidity and political tail-risk complexity.