The smartest business owners I know are always looking ahead. Talk to anyone today who's been in business for more than a decade and they'll tell you that, sure, they're keeping a close eye on current sales, projections, overheads and other issues at hand. But they'll also tell you that most of their thoughts are taken up by the issues they'll be facing two or three years down the line. How will healthcare costs be kept in control? How to find, motivate and compensate the best people? Where will the economy be heading?
And what about interest rates?
Yes, today’s interest rates are still historically low. The Federal Funds rate, which is the rate the Fed uses to loan money to its member banks, is only 1.5 percent. But in the next couple of years, that rate is projected to rise to 3 percent. That's still pretty low. But it's a doubling of current costs - and for many businesses this could be an issue.
Why the significant rise in interest rates over the next few years? There are two big reasons.
The first is that the Fed is unwinding its assets. For many years, the Fed has held about $1 trillion of treasury and other debts on its balance sheet, representing the main part of its asset portfolio. But a big change happened in 2008. During that year's Great Recession the Fed lowered interest rates in order to spur investment. Unfortunately, their actions weren't enough to kick start the economy. So, in a very unusual move, the central bank went on a buying spree. It bought up trillions in U.S. treasury debt and mortgage backed securities. It did this to restore confidence in those securities, stabilize markets and hopefully drive down interest rates even further.
It's debatable whether this action, known as "quantitative easing," helped the country recover from this recession. But we did. Ten years later, the Fed's balance sheet - which has now ballooned to almost $4.5 trillion, remains full of these securities and in order to get things back to where they were regulators announced last October their plans to unwind, or bring down, these assets. Over the next few years, the Fed will let these securities mature without replacing them. This is a giant amount of money that would be flowing out of the economy - a contraction - and if not handled right, it could cause market and economic disruptions. So far, so good - but it's early days. Regardless, the days of holding down interest rates in this manner are over and the Fed is prepared to raise interest rates even more if the unwinding doesn't go as planned. Hence the projected increases.
The second thing pressuring interest rates is the economy. Recent forecasts are predicting an average increase of about 3.0 to 3.5 percent in Gross Domestic Product per year through 2022 or a 21 percent increase overall (2017 GDP is about $19.3 trillion and 2023 GDP is forecasted to be about $23.5 trillion). In order to better manage inflation through this period of growth (and to keep check on the unwinding described above), the Fed has already announced planned interest rate increases over the next few years.
That’s why interest rates are going to go up. Bank on it.
Believe it or not, an increase in interest rates does have benefits for the economy and for your business. It is an indication that inflation is rising and that means rising wages which turns into more consumer spending. It creates more profits for banks, who are then drawn to lend more money (future changes to the Dodd-Frank regulations could also encourage banks to lend more). It will give us more investing options and provide more income on savings not only to business owners but more importantly to retirees and individuals. It may also strengthen the U.S. dollar exchange rate, making goods and services overseas cheaper to buy.
However, there are serious downsides to an interest rate increase, particularly if rates rise too much or too fast.
It increases borrowing costs to both individuals and businesses which could affect housing and construction and investment in capital equipment. It could cause consumers to hit their credit card limits and dampen spending. It puts significant pressure on government spending (even at such low rates, interest on government debt still comprises six percent of federal spending and thanks to tax reform, this debt is expected to significant rise over the next few years). It could destabilize the stock market as money is withdrawn and funneled to other types of investments.
But we know that interest rates are going to increase over the next couple of years. So what should you - the responsible leader and executive - be doing? Remember, you’re paid the big bucks to look ahead and take actions.
You should be locking down rates and converting any variable debt you have into fixed loans. If you're considering a purchase that requires financing you should be getting that financing sooner rather than later and locking down those rates too. You should be inviting in your banker - and their competitors - to look over your debt and cash provisions and recommend (translation: renegotiate) ways for you to get a better return on the cash you have and the cash you've borrowed.
You should revisit Small Business Administration loans if you're a small company or startup or even have up to 500 employees (you're still a small business, according to the SBA). These loans are government backed, sometimes offer better interest rates, and can be fixed for the long term. If you can get supplies overseas you might want to make a short list of potential overseas vendors and grow your relationships because if an interest rate rise causes a corresponding rise in the dollar you'll be positioned to buy product from them at a much lower cost.
It's our job as business managers to anticipate and plan for the times ahead so that we can successfully navigate our companies through them. Our customers, employees, suppliers, partners - and all their families who rely on us for their livelihoods are relying on us to make the right decisions. Interest rates are going up. We need to take action now.