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Rising Rates: What will be the impact of the Fed’s interest rate increase?

In December 2015, for the first time since the Great Recession, the Federal Reserve raised short-term interest rates to a range between 0.25 and 0.5 percent. This was the first step to the ending of the central bank’s stimulus program.

The decision was made as a vote of confidence in America’s economy, though the Fed’s chairwoman, Janet Yellen, said while the economic recovery has come a long way, it isn’t complete. The Fed plans to raise rates gradually if economic growth continues, with the short-term rate predicted to rise by about one percentage a year for the next three years.

Mixed signals

JB Henriksen, partner at Advanced CFO, says interest rates were extremely low for a long time as a way to stimulate the economy. “Now the Fed is basically saying they feel the economy is back on track and they can afford to slow down the economy slightly by raising interest rates,” he says. “I think it was a good idea. The rates have been artificially low for a very long time, and we haven’t really seen signs of inflation. That’s one of the reasons that we could continue to keep it low. A small rise in interest rates won’t slow things down enough to hurt the economy.”

Ramez Halteh, market executive for business banking at Key Bank, says the Fed’s decision wasn’t surprising, because it had been communicating all year to the market that before year end, it would raise interest rates. “It’s data driven. They started looking at the slack in the labor market, and there was quite a bit of slack earlier in the year, which gradually receded,” he says. “They felt it was necessary to begin signaling to the market that their policy of normalizing interest rates is coming back. It was also a message that they felt comfortable enough to increase interest rates without it having significant impact on the overall economy.”

When the Fed raised rates, there was indication in the market that oil prices and the Chinese economy were beginning to be an issue, but Halteh still believes the raise was the right move. “We really didn’t know the extent of China’s woes until the first part of this year. Oil prices are low and China continues to have its issues, so I think [the Fed] is less likely to increase rates in March as we would have thought last year,” he says.

Bruce Jensen, president and CEO of Town & Country Bank in St. George, has a background in controlling short-term assets for large companies in Chicago, London and on the West Coast, which has directly affected his perspective of the Fed’s decision.

“I was really a proponent of the Fed not raising interest rates, but I know I was in the minority,” Jensen says. “My observing over monetary policy was that they would raise interest rates to control certain factors. One is essentially employment. Part of their mandate is maximum employment, but they don’t define what that means. Also they want to keep prices stable, referring to interest rates. The Fed has come out and said they are aiming for a 2 percent interest rate. The main reason they move to raise interest rates is because they don’t want the economy to overheat. With that in mind, I’m looking back on my experience, and I’m asking, ‘Why is the Fed raising rates?’”

Jensen adds that the inflation rate is well below the Fed’s 2 percent target, and it was known in December when they raised rates that crude oil prices were imploding. “We know inflation isn’t going to be a challenge for some time, and when you look at the employment side, we are in the fourth and longest expansion since World War II. It’s also the weakest of those four expansions. While employment has been increasing, the labor participation rate is subpar.”

Jensen attributes enormous political pressure as one of the main reasons the Fed chose to increase the rates, because if the economy were to take a hit, with interest rates as low as they were, the Fed wouldn’t have had any tools at its disposal to stimulate the economy. But because the world is in a global recession, Jensen feels the Fed’s decision was premature.

“Right now you have our Fed that’s going against the global trend by raising rates,” he says. “What that’s doing is putting pressure on the U.S. economy, and it makes the U.S. dollar more attractive so we can’t export as much, which slows down economic growth. I just don’t see the real basis.”

Some of the headwinds Jensen believes the U.S. is facing, which are directly affected by interest rates, include wages that aren’t rising, corporate earnings trending lower, durable goods orders being down, manufacturing being down and excess inventories laying around.

“We do not have a robust economy here,” he says. “When the Fed raises rates it’s to keep an economy from overheating. I think it was a mistake that could have a global impact.” Although Jensen is concerned, he says because Utah has a “very vibrant and diverse economy,” even if the American economy is hurt, he doesn’t believe Utah will be hurt as badly.

Business impact

Overall, Halteh believes the interest rate increase is more psychological than anything else. “Yes, a quarter of a percent increase is something for businesses that have working capital lines of credit and SBA clients that have the SBA 7(a) [loan] that is primarily off of prime, but in the overall scheme of things, it’s not that significant,” he says. “The long-term interest rates are still low.”

Jensen agrees that the rising rates are more symbolic at this point. “Most banks in Utah are positioned so that rising interest rates won’t hurt us, and most loans are priced on a variable rate basis,” he says. “As rates go up, we aren’t going to suffer. Those increases weren’t material enough to make a difference, but contemplation of raising additional rates in 2016 is a bad idea unless there’s evidence of more robust growth than we’re currently seeing.”

Halteh adds that new long-term loans won’t see a difference, but businesses that utilize treasury management will see an increase in earnings credits to offset fees. In addition, businesses that have savings accounts may also see a slight increase. “In general, the [rate increase] hasn’t had much of an effect on loans either,” he says. “Loans typically look at long-term pricing, where day-to-day money is more short term. Hopefully our clients are doing better and don’t mind the quarter of a percent increase on funds, because if short-term rates are going up, that ultimately means the Fed thinks the economy is doing well.”

Henriksen says businesses are going to pay a little more for the money they borrow, but the new interest rates won’t mean much to the finance and lending institutions. He predicts businesses will potentially slow down their borrowing. “I’ve seen businesses spend huge amounts of money on capital expenditures because rates were low,” he says. “I do think construction will slow and a lot of other things that have been growing very rapidly will slow to a healthy pace. The growth we’ve seen with construction has been growing faster than it should.”

Because interest rates are still so low, Henriksen says, new loans may be slowed slightly, but there won’t be much of an impact. “People will still be buying homes, businesses will still be building—at this point it’s healthy for the economy,” he says.

Looking forward

Halteh says it’s hard to predict if the Fed will continue to raise interest rates in 2016, but if the first quarter of the year is strong and inflation begins to pick up, he thinks there’s an increasing likelihood that the Fed will increase rates again. “They’re extremely data driven, and we have a new rotation with federal open market committee members, and these particular members are more likely to raise rates,” he says. “Ideally, I think there’s plenty of room for rates to go up another quarter or half a percent.”

Henriksen doesn’t believe the Fed is done when it comes to raising interest rates, particularly because rates have been artificially low for such a long time. “They need to come back up to a more realistic rate for our economy,” he says. “I don’t think the Fed is going to move quickly, maybe another quarter of a point to a half a point at the most [this year]. With the turmoil in the stock market, it’s going to slow them down from wanting to make too many changes.”

Jensen says he doesn’t think there’s a basis for another increase any time soon. “I don’t think the increase will be big if any, and in my mind, I just don’t see rising rates as justified,” he says. “That doesn’t mean I don’t believe it’ll happen, but based on today’s analysis of the global economy, I don’t think it’s warranted.”

Halteh suggests business owners talk to their banks to figure out what makes sense for their business. “If we have clients whose loans have matured and they’re looking at relocking rates, we’re looking at five, seven and even 10-year money. Businesses need to be having active conversations with their bank to look at the pros and cons of how long to go out with a loan. Construction costs will also go up a little bit for commercial owner-occupied properties. Clients looking at building buildings, because subcontractors went away during the recession, will see more demand in commercial construction and see costs go up.”

Jensen adds that those who have business overseas need to recognize the impact on their revenues because of the stronger dollar. “If they are exporting or providing global services, that will hurt them,” he says.

Henriksen says business owners also need to realize the economy will slow down slightly, and they need to prepare their businesses accordingly. He adds that general consumers will also see a bit of a difference, in the form of slightly higher mortgage rates and other loan rates.