Since starting the current rate increase cycle in December 2015, the Federal Reserve (Fed) has raised the target range for the Fed Funds Rate six times: from a historical low of 0.00-0.25 percent to 1.50-1.75 percent, as of the March 2018 FOMC meeting. With a growing economy, growing levels of employment, and a recent uptick in inflation indicators, it’s anticipated that the Fed will maintain, and potentially accelerate, its current path of rate increases.
During the last full cycle of Fed tightening (2004-2006), the target rate rose from 1.00 percent to 5.25 percent.
The interest rate environment can affect the economy in a number of expected and unexpected ways. Given it’s been over a decade since the last Fed tightening cycle, we at U.S. Bank, think it’s important to take time to carefully consider how rising rates can impact our business clients.
Specifically for middle market organizations, those with $10 million to $500 million in annual revenue, there are three questions to ask:
The Fed has communicated its intent to continue raising rates in a gradual and incremental manner. As this happens, borrowing costs on floating rate debt and yield on floating rate investments will both usually increase. If the Fed accelerates its pace of increases beyond current expectations, yields on floating rate debt and investments may accelerate at least as quickly, if not more.
Now is a good time for you to look at the composition of your balance sheet, and determine how higher interest rates could impact profitability.
As a business owner, you want to think about the possible side effects of rising rates, whether positive or negative.
From a broader point of view, we interpret the Fed raise in rates as a sign of optimism. It’s an indication that the economy is improving, and that’s great for the middle market.
This is an important question. Some organizations may be comfortable with their level of exposure to interest rate variability and others may want to explore financial tools such as swaps or caps to mitigate part of the risk. You may also want to act while rates are still at historic lows. At U.S. Bank, we’ve helped a number of clients take advantage of low rates in credit and debt markets to finance M&A, and long-term assets like real estate.
It’s a good time for business owners to consult their banker or interest rate specialist. Your bank should be able to understand your business, and bring an expert into the discussion. This can help you understand the impact of rising interest rates: how both sides of your balance sheet will perform as rates continue to rise. It can also help you properly manage through the changing economic environment, and help drive predictability for your business — regardless of the path the Fed takes in the months and years to come.
Elliot is executive vice president and head of Commercial Banking at U.S. Bank. He has more than 25 years of experience in financial services, with a focus on serving middle market businesses in a variety of industry sectors.