When the Federal Reserve Board meets later this month, there's a better than 50-50 chance it will raise its benchmark interest rate for the first time in seven years. And if it doesn't happen this month, then expect a hike to go through when the Federal Open Market Committee gathers for its final meeting of the year in December, financial experts say.
The interest rate bump is likely to be small, on the order of 0.25 percent, and entrepreneurs won't feel much immediate impact. But the rate increase is likely to be the first of many. The hikes ultimately will return the central bank's key short-term rate, called the federal funds rate, to about 4 percent over the next two years, which economists generally consider more a sustainable level. The federal funds rate is currently at 0 percent.
Increasing interest rates is necessary, economists say, to keep the economy strong. Raising rates would head off the threat of too much borrowing using cheap money, which contributed to the last recession, and it will also give central bankers some room to maneuver, should the economy start to underperform again. Other reasons for an increase include heading off a deflationary debt spiral, and conversely, the risk of very high inflation.
U.S. markets have already factored in the effects of an initial increase, since Federal Reserve chair Janet Yellen has essentially made clear for months that rates will begin to go up this year. Still, there's a chance they'll experience some volatility when the day comes, and share prices might fall.
Apart from that, small-business owners are likely to experience the increase in three important ways.
1. Your borrowing costs will go up. The federal funds rate is the rate that banks use to set the prime rate, their own lending floor for everything from credit cards to lines of credit and commercial loans. So expect the higher rate to get passed along to you.
Glen Dobi, founder and chief executive of Dobi & Associates, an Inc. 5000 honoree and a manufacturer of specialty wood chips used for barbecues, says a 0.25 percent increase will add $5,000 to the $50,000 he pays annually in interest for his line of credit from Comerica. He uses that to finance operations for his business, which produces $12 million in annual revenue. "When the Fed increase goes through, it will affect our base rate, and it will be cleanly passed through as a quarter percent increase to our interest rates," Dobi says.
2. If you manufacture or hold inventory, running your operations will get more expensive. That's because production cycles require businesses to finance their operations before customers pay up for their goods. Most businesses, such as Dobi & Associates, do that with lines of credit.
Adds Denis Horrigan, a partner at financial advisory Connecticut Wealth Management, in Farmington, Connecticut: "Business owners may want to consider locking in to the current low-rate environment with any financing needs they have for equipment purchases or construction."
3. Increasing interest rates will strengthen the dollar by creating demand for interest-bearing securities, such as U.S. treasuries. While the dollar has already become one of the strongest global currencies in recent years, an even stronger dollar will make your products more expensive in export markets. "The biggest issue for those companies is that the dollar will strengthen, and that will lead to a fall in competitiveness," says Roberto Rigobon, a professor of applied economics at the MIT Sloan School of Management.
Dobi says there is an upside, however. He manufactures his product in Canada, where a strong U.S. dollar is expected to bring down his company's manufacturing costs. "We're an international manufacturing company, and Canadian interest rates aren't expected to go up, and the Canadian dollar will soften," he says.