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Over the past few years the global economy had gone through one of the worst recessions since the great depression. When we tried to point fingers at who was responsible, everyone blamed everyone; however, no matter how much finger pointing was done, the key to any bull market or recession is fiscal policy controlled by the government.

Why is Fiscal Policy so Critical in determining the Market?

The government has the ability to deliver the inflows and outflows of money in and out of the economy at anytime. They also have the ability to increase or decrease taxes to take more an less money from the economy. The third item is interest rates. The government has control over prime rate which is the key lending rate. By adjusting these 3 critical elements, then they can make major changes to everyone’s spending habits, companies hiring policies, consumer confidence, and inflation. If the government allows for too much money to enter the economy too quickly, then this can cause great inflation and an overinflated currency, higher house prices, and overinflated equity prices. The market will then cause a recession to bring these prices back in line. On the inverse, if the government takes too much money out of the economy, then deflation will occur and prices will decrease to match the levels of currencies available.
During the last 7 years, the US government had set the key lending rate lower for a longer duration of time than usual. This caused the markets to flourish with all this extra money in the economy. House prices inflated, and equities went on a several year winning streak; however, once that was over, then we has a major recession. This cycle the government cannot afford to make the same mistake again.

The Governments next move

The government is planning on keeping the key lending rates at their all time lows until after the unemployment level peaks. Once unemployment levels begin to subside, then this is a key indicator for banks to begin rising prime rate. When prime rate moves up it usually moves by 25 points or 50 points; however, in an effort to not make the same mistakes as the past, then the government will move up the interest rate as much as possible as long as it will not cause shock in the market place. The goal of the government is to have slow continual growth. By having rates at the current level for too long will cause dramatic inflation, so in order to counteract the inflation, then the government must make decisive actions to protect the future economy. The goal of the Canadian economy is to achieve a target inflation level of 2%, so usually prime rate is above the inflation rate. In order to achieve this, an aggressive tightening of the interest rates is necessary, and the rate must move up quickly.
An increase of prime rate within a short duration of time to above 3% would not be unlikely. If this were to occur, then we could see bank prime rates at 5% and higher and fixed rates in the 6% levels.

Unfortunately, no one knows exactly what the future has in store, and many analysts have made observations that have been wrong over the past few years, so you will need to take this with a grain of salt; however, a word to the wise is to prepare for the worse. It is never a good idea to have a mortgage payment that is greater than 40% of your monthly income.

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