Today’s rising interest-rate environment is a popular topic of conversation at corporate conference tables — as well as family kitchen tables – across America. Investors, financial advisors, stock brokers, securities traders, bond portfolio managers, and consumers alike have a stake in understanding the implications of the higher interest rates we’ve seen in the last three years—and in anticipating future rate hikes. Bankers are not alone in discussing the rising interest rate environment, and dissecting the likely timing, impact, and duration of future rate increases.
Rising interest rates — directly and indirectly, for good and for ill — exert a profound impact on America’s economy, consumers, and businesses. They influence the amount of money that middle-class families save, the investment strategies that corporations deploy, and the investment advice that individuals receive. In addition, rising interest rates help determine which stocks will pay a higher dividend, which bonds will produce higher yields, and which money market accounts have the highest rate.
What is a Rising Interest-Rate Environment?
Our current rising interest-rate environment is not a new phenomenon, and we need only look back 40 years for another paradigm example. In an effort to fight double-digit inflation in 1979, the Federal Reserve increased the benchmark federal funds rate until it reached a high of 20% that same year (and again in 1980). A more recent example underscores this cycle as well: Between the summers of 2004 and 2006, interest rates increased 17 times in 24 months.
Over the past decade, however, rate increases have become distinctly less familiar to us. On December 16, 2008—in the midst of the Great Recession—the Federal Reserve lowered the benchmark funds rate to 0.25% … the lowest possible rate.
Over the next 84 months, as the economy slowly resuscitated, the Fed raised interest rates exactly zero times. Finally, on December 17th, 2015, when it was determined that economic growth had stabilized, Fed Chair Janet Yellen authorized an increase to 0.5%.
With the Fed responding to ongoing, stable economic growth, interest rates maintained a consistent upward arc throughout last year, reaching their current rate of 2.5%k on December 19th, 2018. The Fed signaled in March of 2019 that rates are not likely to change in the near term.
To hedge against inflation as the economy continues to grow, 2019 rates are expected to reach 3.0%.
What Are the Potential Impacts of a Rising Interest-Rate Environment?
When the Fed increases its benchmark rate, it is simply mandating that banks must pay more for the money they borrow from the Fed. Money becomes more expensive for banks and, in turn, quickly becomes more expensive for everyone else. The Fed’s rate hike for the nations’ banks creates a series of tremors that reverberate from Wall Street to Main Street and throughout the entire economic landscape. All other interest rates, some directly, some not, are affected as well.
Banks pay higher interest rates to customers for fixed-income accounts like savings accounts, certificates of deposit, and money market accounts. In turn, customers will see a spike in short-term rates (car loans, credit cards, home equity lines of credit, and adjustable-rate loans) and long-term rates (fixed-rate mortgages and student loans).
In a rising-rate environment, businesses may consider it prudent to seek fewer loans and reduce costs. Existing plans to launch new initiatives or expand industries may be delayed or eliminated entirely. Hiring may slow or stop. Workforce reductions may even occur. If a company is perceived to be delaying growth – or if reduced revenues and higher debt costs cause it to be considered less profitable – the value of the company’s stock will fall. If stock prices fall for multiple companies, the whole market, or particular indices, may decline. As confidence in the market falls, stock ownership may decline because ownership is considered too risky and simply less attractive than other investment options.
FOR INDIVIDUAL CONSUMERS
A rising interest-rate environment presents both challenges and opportunities. One positive for consumers is that banks will pay a higher rate to customers for fixed income accounts like savings accounts, certificates of deposit, and money market accounts.
At the same time these fixed income accounts begin to pay more, borrowing becomes decidedly more expensive. Short term rates go up. Individuals will pay a higher interest rate to finance a new car. Customers with credit cards will pay a higher rate and, if they carry a monthly balance, they will incur a higher monthly minimum payment. Customers with adjustable-rate mortgages will begin paying more for them. Long-term interest rates, like those offered for home mortgages will also increase. Private as well as federal student loans that charge variable rates will cost more. Discretionary income will, typically, be reduced.
We can expect interest-rate hikes to increase profits. The yield on a bank’s cash holdings increase in direct proportion to increased interest rates, and earnings will grow accordingly.
Not all banks, however, can enjoy increased profits. In fact, many community banks are harmed by rising rates. Many community banks see their markets reduced, largely due to competition from larger institutions who use daunting marketing budgets to tout a blizzard of supposed advantages.
As these community banks do battle with larger competitors they’ve seen their net interest margins shrink because of higher deposit costs. These community banks, which are struggling to effectively compete with other financial institutions in their market to attract low-cost deposits that will fund loans, are hoping that the Fed will reverse course, and lower rates. (For more on growing deposits, read A Proven Deposit Growth Strategy for Your Community Financial Institution)
How Long Will Interest Rates Continue to Rise?
For both consumers and banks, a cycle of rising interest rates – following a seven-year period of zero interest rate growth – was inevitable. How long will this cycle last? No one can say with certainty, but many experts expect at least three more years of gradual rate increases.
Strategies to Thrive as Interest Rates Rise
FOR INDIVIDUAL CONSUMERS
It is important to recognize the current rising-rate environment for what it is: a predictable and measured response by the Fed to seven years of artificially low rates, and, the result of an economy that continues to grow.
That said, there are several prudent steps individuals can take as interest rates continue their upward trend, including:
- Reducing or eliminating outstanding credit card debt. The rate of interest consumers will pay on credit cards will continue to increase in the current environment.
- Availing themselves of attractive opportunities to save. As rates continue to rise, consumers should avoid committing to long-term certificates of deposit. By doing so, they’ll be more likely to have an opportunity to secure higher rates at a future date.
- Steering clear of adjustable-rate mortgages. For those buying or refinancing a home, fixed-rate mortgages are a more prudent choice.
Like the aforementioned community institutions struggling to grow core deposits and increase profitability, Haberfeld confidently recommends a solution we consider both wise and unconventional.
An abbreviated version of this solution is:
The typical community bank has the immense excess capacity to serve more new customers. New customers that look, deposit, save, and borrow just like the existing base of customers that you already serve. So, how can we gain the business of these customers? We recommend that these community banks begin using a cost-effective and omni-channel marketing approach that blends big data with new technology and proven fundamentals.
The projected result: Your bank will acquire new customers who live, work, and own businesses near your branches, along with customers who shop, dine, and travel within your network of locations. We believe that if your bank effectively deploys an omni-channel marketing strategy—in tandem with a disciplined attention toward properly aligned staff, products, policies, and values—you will see:
- Doubled customer acquisitions;
- Secured low-cost core deposits; and
- Restored profitability.
By Grant Ossenkop, Vice President