ALEXANDRIA, Va. — As the National Credit Union Administration continues to urge CUs to prepare and adjust their internal risk models to take into account the possibility of rising interest rates, what are likely scenarios regarding when the Federal Reserve will actually make a move?
At its March meeting, the Federal Reserve's Federal Open Market Committee (FOMC) refrained from raising the benchmark overnight rate following a slight (but historically relevant) uptick in rates announced at the December 2016 meeting — to the 0.25%-0.50% range.
More importantly, Fed members suggested that future rate hikes would likely come less often and less aggressively than industry insiders predicted.
And on Tuesday, in a speech at the Economic Club in New York, Federal Reserve Chair Janet Yellen reiterated her stance on proceeding "cautiously" with interest rate hikes — strongly implying the central bank will again keep rates unchanged at its June meeting.
"Given the risks to the outlook, I consider it appropriate for the [FOMC] to proceed cautiously in adjusting policy," Yellen said. "This caution is especially warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric."
But Yellen also said that if economic conditions were to "strengthen considerably more than currently expected, the FOMC could readily raise its target range for the federal funds rate to stabilize the economy." In contrast, she added, if the [economic] expansion "was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero."
Brian Turner, president of Meridian Economics LLC, a consulting firm in Plano, Texas, noted that the FOMC changed its rate forecast for both 2016 and 2017.
"Originally the Fed had projected rate hikes of 25 basis points at every other scheduled meeting in 2016 — a total of four adjustments or 100 basis points," Turner told Credit Union Journal. "Their new forecast shows only two projected hikes for the remainder of 2016, or 50 basis points."
This underlines what challenges the Fed faces — namely, instituting policies to increase short-term interest rates without creating an adverse impact on consumer spending during what appears to be a protractedly fragile national economic recovery.
"To raise short-term rates too soon, too high, too fast would slam the brakes on already fragile consumer spending, slowing economic growth even lower than the [current] weak 2.3% pace, threatening another deep recession with fewer remedies available to the Federal Reserve," Turner warned.
The NCUA said that the Federal Reserve has indicated that, if the economy continues to grow, and the unemployment rate approaches full employment, and inflation is around or above its 2 percent target, the central bank is likely to move interest rates higher this year.
"Right now, projections indicate an increase of about 50 basis points through the end of this year and another 100 basis points next year," said Ralph Monaco, NCUA's chief economist, said. "So, the likelihood of Federal Reserve increases depends on how the economy performs. As we saw at the last Fed meeting, when they didn't raise rates, they are focused [more] on economic risks and performance."
The bottom line, NCUA added, is that there is still uncertainty, including at the Fed itself, about the likelihood of rate increases.
Mike Schenk, Credit Union National Association's vice president of economics and statistics, said his organization expects the Federal Reserve to raise interest rates carefully and gradually this year — perhaps at every other meeting — to finish the year up by 50 to 75 basis points. That would place the Fed Funds rate in the 1.00% to 1.25% range by the end of 2016.
Schenk noted, those individuals and institutions currently trading in the Fed Funds Futures market are taking a more cautious view — based on their transactions, they are expecting only about a 0.25% hike in rates this calendar year.
"We think labor markets will continue to improve this year, with unemployment declining and real wages (i.e., inflation-adjusted take-home pay) rising," he said.
This should help to push up consumer demand for big-ticket items, which, in turn, will boost the loan business at CUs, according to Schenk.
"We are also confident that, in percentage terms, loan growth at credit unions will remain [at] near double-digit levels this year," he said So, as credit unions issue more higher-yielding loans, the potential negative impacts on the bottom line as a result of higher interest rates will largely be offset, he added.
But Turner also noted that for most credit unions, higher short-term interest rates might actually be a "blessing."
For many credit unions, he noted, a 50-basis-point increase in the Fed Funds Rate on surplus cash would have the same impact on revenues and return on assets as a 10% increase in 15-year first-lien mortgages or a 15% increase in vehicle loans at prevailing market rates.
"The higher cash position also helps the credit union transition into any pending rising rate environment and ensures funds are available to meet quality loan demand when credit markets improve," Turner added. "For some credit unions, this might be a good opportunity to unload some of their undesired longer-term investment holdings — although it must closely evaluate the adverse impact on current earning streams before execution. In some cases, the impact from high cash rates may cover the earnings loss from the sale as would re-investment into whole loans."
Credit unions should not fear rising short-term rates on costs of funds — at least at the onset, according to Turner. "Given [the credit union] industry's strong liquidity profile and outlook for share growth, competition for funds will be modest," he said. 'This will help to minimize the pressure on higher share rates.
