Recently the Federal Reserve raised interest rates and indicated they would likely continue until inflation is under control; this led economists and others to warn about worst-case scenarios, including a recession. Amidst all this chaos and noise, it can be very difficult to understand how those actions, and subsequent reactions, might affect businesses.
As a banker who has worked closely with companies of all sizes for nearly forty years, I’d like to recap what’s happening, how it affects businesses, and offer some advice I’m giving to business leaders for the coming months to navigate the best way forward.
Recent History of Interest Rates
Going back to The Great Recession of 2008, to stimulate the economy the Fed lowered rates close to zero and it stayed that way for a long period of time. In 2016, the economy started to heat up and the Fed began raising rates again to keep inflation in the target range of 2-2.5%.
The emergence of COVID-19 in late 2019 sparked severe economic impacts on the global economy; in response the Fed lowered rates back down to almost zero in an effort to drive demand. At the same time, various federal loan programs like the Paycheck Protection Program were introduced to provide further support. This had a beneficial effect on businesses by supplying them with reserve liquidity, helping with demand, and leading to increased levels of employment. However, supply chain issues emerged, and, in many cases, companies could not get raw materials to make products like cars and homes. This is classic supply and demand; the supply chain pinched availability of raw materials and finished goods, so we started having to pay more for them.
In a perfect world, companies would figure out how to make more products or source more raw materials from another place. However, that hasn’t been easy to solve. As an example, the cost of building materials skyrocketed, impacting housing, with tenants paying higher rents and demanding increased wages to cover these costs.
Inflation in 2021
As late as fall of 2021, the Fed was still labeling inflation “transitory” because they felt higher prices were temporarily caused by a COVID-19 hangover, and that supply chain issues would resolve. They felt the market would adjust and prices would revert to normal. Over time, the Fed’s language started to change. They spoke about certain categories where inflation was more sustained but still believed the overall picture was manageable.
As it became evident that these issues would take longer to resolve, the Fed began signaling that higher prices were problematic, more sustained, and spoke more emphatically about moving interest rates higher, more quickly, to dampen inflation. The Consumer Price Index, that famous “basket of goods,” started showing more key components experiencing significant price increases. It all felt incremental — until it wasn’t.
Russian Invasion of Ukraine
In February 2022, Russia invaded Ukraine, causing a huge disruption of the European and world economies. Western nations worked to act in an organized fashion to punish Russia by not buying oil and imposing other economic sanctions. Among other things, this began to impact the flow of oil, leading to higher gas prices.
All these price factors affect how people feel about their available income, whether they go on vacation, buy a new home or a car, or whether they stop spending money, which can lead to a recession.
The Fed Raises Interest Rates
In June of 2022, the Fed raised interest rates by 75bps (basis points), or three quarters of a percent. This was a more aggressive action compared to more typical Fed rate increases, which, in the past, moved in 25 bps increments. In fact, it was it was the largest rate hike since 1994. The latest news shows that nearly three-quarters of economists expect the Fed to raise rates another 75 bps in July and a majority expect it to raise rates another 50bps in September.
Raising interest rates is a way for the Fed to control inflation. Higher interest rates make it more costly for businesses to borrow money through loans and lines of credit and affect how much interest you pay on your credit card or home purchases. The impact of this generally ripples through the overall economy.
The Fed faces a difficult balancing act. In concept, it is an effort to slow things down in a moderate, more controlled way, giving the economy time to adjust and rebalance, with a reduction in inflation as a desired result. However, if demand drops too rapidly, we risk dipping into a recession in which the economy shrinks.
How Are Businesses Affected?
As previously discussed, in the short-term, rising interest rates increase borrowing costs. This could impact purchasing and investment decisions for both businesses and consumers, cooling demand. It is important to consider how this may affect your business, including your tactics and strategies for the next few years.
For instance, if your company has plans to invest in automation because you cannot find enough workers, it may take more time to acquire the necessary equipment/robotics, the cost of the project may change, and the return on the investment may be impacted. With these considerations, how might you adjust your approach? Will it affect your firm’s sales or margins?
On a more personal level, either for business leaders or employees, how do changes and volatility in financial markets influence investment decisions or retirement plans?
What Can Businesses Do About Rising Interest Rates?
Economically speaking, it’s difficult to predict where we’re headed in the long term, but we can take hope in some basic truths and offer our perspective for the coming months and quarters.
1. Start with your banker, accountant, and attorney. Relationships with these experts are very important at this time, much more so than when everything is going great. Life is easy when demand is strong and rates are low. These key partners can help you get through chaotic times. Think of them as an extension of your team to provide individual advice and insight. You should be able to bring your plans or scenarios to your trusted advisors to assess viability and how they impact the economics of your decisions. Sometimes we say things that are tough to hear, but honest communication both ways is important in any long-term relationship. Bankers should provide best practices, insight, advice, and ideas to help you get to a good position.
2. Consider your cash management strategy. Your bank’s Treasury Management advisor can help review your current practices to optimize your treasury or accounting function. Our Treasury Management professionals regularly talk to business leaders about their cash conversion cycle — how quickly money is collected versus the pace at which you send money out the door. That can have a material impact on your borrowing needs, your line of credit, and interest expense on your income statement. Bankers have tools and techniques to accelerate cash collection and slow down outflows to vendors, and to improve efficiency in your back office.
In the low-rate, low-return environment of the past several years, there have not been many options for deploying your cash. However, in a rising-rate environment, businesses with liquidity may want to consider different possibilities for operating, reserve, and strategic cash, while not losing sight of risk tolerance. Do you have an investment policy? If yes, it may be time to revisit it; if not, this is likely a good time to establish one considering current economic conditions. Alternatively, is now the time to reduce leverage for your business better by retiring debt with excess liquidity?
3. Structure borrowing decisions advantageously. If you are about to buy a piece of equipment, real estate, or considering an acquisition, be sure you know the return for that investment decision in basic terms. Rates may reach a level that may impact these assumptions. A trusted banker can advise you about how to structure a loan, including evaluating the amount of cash into the transaction, trade-offs relative to longer or shorter amortizations, and the overall debt capacity of your firm. You should expect a relationship-focused banker to welcome good, open communications between the bank and your company around what is the appropriate way to approach borrowing decisions.
Final Thoughts On Navigating Rising Interest Rates
Sometimes it takes difficult times to emerge as a stronger business. We hear it quite often when the economy is challenging: our clients appreciate the hands-on, relationship focus we take with their business, and they depend on our guidance. If you feel your company would benefit from this type of a banking partner, we welcome the opportunity to start a conversation.
Last Updated: 07/25/2022