After years of predictions that interest rates would soon be on the rise, the general consensus among economists is that economic conditions in 2016 have laid the groundwork for the Federal Reserve to raise rates multiple times next year.
Another strong jobs report in November bolstered those predictions, leading to likely consequences for banks and credit unions. However, the central bank — after hiking rates by 25 basis points last December for the first time in nearly a decade — repeatedly refrained from tightening this year, despite offering tantalizing hints it would, based on evidence of a strengthening economy.
Now in the final month of 2016, buoyed by a nine-year low unemployment rate in November (4.6%), virtually all experts are expecting a rate hike in mid-December, followed by probable increases next year. But questions remain about how often the Fed will increase rates and how many times it will make such a move in the coming year.
Brian Turner of Meridian Economics in Plano, Texas, holds that it's "reasonable" to expect the Fed's benchmark overnight target rate to increase to 1.25% to 1.50% by the end of 2017, depending on the relative growth trend in the economy.
"Quite frankly, another 50 basis point increase in the funds rate will have little impact on the economy and would give the Federal Reserve something to demonstrate they are still relevant," he said. "The level of liquidity that remains in the market (from the massive injection following the Great Recession) most likely caps the funds rate between 1.5% to 1.75% in the pending cycle."
Curt Long, chief economist at the National Association of Federal Credit Unions, took a more cautious approach. Citing that economic returns have been "fairly positive" in the second half of 2016, Long he expects just two rate hikes next year if current trends continue. "But this recovery has been anything but smooth, and my expectation would be for some ups and downs in 2017, ultimately resulting in just one rate hike," he said.
Dwight Johnston, chief economist at California and Nevada Credit Union Leagues, speculated that the Fed might raise rates as many as four times over the course of 2017, though he acknowledged that there are some significant risks. Chief among them, he said, are upcoming elections in Europe which suggest that growing populist movements in France, Italy and elsewhere, might ultimately lead to a collapse of the European Union, echoing back to the historic "Brexit" from earlier this year.
"This is not a high-odds occurrence, but it can't be dismissed," he said.
Ralph Monaco, the chief economist at National Credit Union Administration (NCUA), said he expects the Fed to continue to monitor the real economy — jobs, unemployment, and economic growth — as well as the inflation rate and the general state of financial markets.
"If the incoming data suggest further declines in unemployment, rising inflation and relatively calm financial markets, then further rate increases would seem likely," he stated. "The Federal Reserve has repeatedly indicated it is data-driven; we should take their comments about this seriously. Private economists have, in opinions consistent with continued growth and higher inflation, indicated that they see the federal funds rate well above 1 percent at the end of 2017. But faster growth and higher inflation could lift that figure, just as slower growth and lower inflation could put the Federal Reserve on hold."
The Trump Factor
Even more than the Fed, perhaps the biggest question mark facing the U.S. economy as the calendar turns to 2017 is the matter of President-elect Donald Trump.
During his campaign for president, Donald Trump took critical aim at the Federal Reserve and chairperson Janet Yellen for "creating a false economy" by keeping interest rates too low — only to praise Yellen months later by warning that raising rates "would be a disaster."
Turner agrees that the protractedly low rate environment has created the potential for dangerous market sector bubbles, particularly in the stock market, which could crash when borrowing costs rise.
"Ironically, Fed policymakers who have dissented putting off past rate increases have mentioned this very same opinion with a warning it could destabilize the financial system," he said.
But Johnston is optimistic. "The Fed will respond to whatever economic impact [Trump's] policies have," he predicted. "Currently, there is a lot of optimism his policies will be a boon to businesses. If… the result is stronger growth and higher inflation, the Fed will respond. But, the Fed will not respond immediately to [his] policy changes, only [if] they see [that] the economic impact of changes really are not what [they] expected."
Indeed, stock markets have soared since Trump's election.
Turner conceded that higher rates are needed for the economy, "but you can be sure the new administration will react quickly should the upward pace begin to trend too high."
NAFCU's Long said if Trump is able to push through a meaningful stimulus package built around infrastructure spending and tax cuts, that could have a meaningful impact on growth in the short term —
If President-elect Trump's policies lead to faster growth, lower unemployment and higher inflation, Monaco proposed, then interest rates are likely to rise. But if the economy sputters — for any number of reasons, many of which might have nothing directly to do with the new administration's economic policies — then rates could be flat or even decline.
"Policy could have a big impact on rates — or a small impact or no impact at all," he said.
What Now, CUs?
So how should credit unions prepare for a potential escalation in interest rates?
Johnston believes credit unions are "in good shape for the most part" to deal with rising rates and only a few credit unions might be concerned about interest rate risk.
"If… rates go even higher, the refinancing business will fall by at least 50% or more next year," he predicted. "But, [the] purchase mortgage business could be good in a positive economic environment. It will get a little iffy if mortgage rates start to move sharply higher though. The focus this coming year might be less on loans and more on bringing in longer-term deposits."
Plus, credit unions might have to be more competitive in rates on money market accounts and the like, Johnston cautioned. "With all institutions paying little to nothing for years, consumers have had no incentive to shift funds from institution to institution," he explained. "That could change in a rising rate environment."
Turner proposed that those credit unions that have heeded the counsel to increase their liquidity profile over the past year will benefit the most in 2017. "Despite any projected increase in the Fed funds rate, don't expect consumer rates to follow in step," he cautioned. "Yes, they could be slightly higher, but market demand and member spending behavior will dictate the pace. On the other hand, mortgage rates — particularly fixed-rate loans — will move more in line with benchmark Treasury rates until the economic environment begins to sour and home purchase applications begin to taper off."
Existing home sales hit recent highs in October while new home sales declined.
Turner predicted that loan quality will continue to get better across the industry as the economy improves and wage growth increases
"This would permit many credit unions to take on a little deeper loan quality beyond the B+ minimum that has been a strategic recommendation of mine over the past 15 months," he said. "Many suppose adjustable-rate loans would be in line for 2017, however history tells us weak member demand for this product and lower total return outlook for this product line should discourage it.
The most beneficial plan for many credit unions in 2017, he asserted, is to retain a balanced loan-origination strategy that doesn't grow the portfolio too fast and to do so without compromising credit underwriting standards. "The period for accelerated growth strategies could come later in 2018," he concluded.
A quarter-point rate hike probably won't result in too many "meaningful changes" for credit unions and their members, NAFCU's Long cautioned. "But as membership growth has been high and wage growth has started to take hold, credit unions have started to see some significant increases in share growth," he countered. "That's something that credit unions may have to manage around in 2017."
NCUA's Monaco noted that the regulator has been cautioning credit unions about preparing for rising interest rates for some time. "Credit unions need to analyze and understand what can happen to their income statements and balance sheets under a variety of interest rate scenarios, including one in which short-term interest rates are rising, both as part of a rising yield curve and part of a yield curve flattening," he said. "Once armed with the right information, individual credit unions, as they have traditionally done, will make good choices for their members."
