“We know the Federal Reserve is planning to raise interest rates sometime this year. What we don’t yet know is how that might affect business owners and operators,” says John Hayes, executive director of the Pennsylvania Middle Market in Chase’s Commercial Banking group.
Smart Business spoke with Hayes about what businesses need to know and do to prepare for the higher rates.
Interest rates are currently at zero. Why is the Fed set on raising them?
The Fed has a dual mandate — to simultaneously control inflation and to achieve full employment.
One of the Fed’s actions in response to the recession was to stabilize the U.S. economy and financial system by implementing a ‘zero interest-rate policy’ to reduce short- and long-term interest rates. This helped spur employment, restrain inflation and finance spending in a time when many businesses were struggling.
Capitalism, however, is based on interest rates being above zero. The Fed’s goal in raising interest rates will be to remove the unnatural stimulus that’s been in place since the recession, and to do that, it’ll move rates back to something more normal, which is likely in the 3 to 4 percent range.
How much should businesses worry?
In short, rising interest rates shouldn’t be a threat to businesses — when the Fed raises rates, it will be a result of the economy doing better. Interest rates were above zero before the recession, and eventually, they’ll have to return to a number above zero to support a healthy and robust economy.
So far, the Fed has shown great patience when timing this long-anticipated rate hike. It has been cautious not to disrupt the economy’s growing momentum by normalizing rates prematurely.
The rate hike’s pace will likely be governed by the same sense of caution. Barring the unlikely reappearance of strong inflationary pressure, the Fed will likely be reluctant to take any action that disrupts markets or upsets expectations. And as interest rates slowly lift from near zero, the benefits of a stronger economy will more than outweigh the higher cost of borrowing.
How will higher rates impact the stock market?
While bond yields are certain to climb with rates, they are unlikely to lure investors away from stocks, which are poised to continue rising on strong corporate profits.
Current stock prices are aligned with historic norms — stock gains have paralleled growth in earnings, and the market’s average price-to-earnings ratio is consistent with past periods of economic expansion. There is little reason to believe the market’s gains have been fueled by easy money, or that the end of rock-bottom interest rates will diminish the potential for future growth.
Let’s talk timing — when can we expect the Fed to start raising rates?
If the Fed intends to wait for definite evidence of inflation before raising interest rates, the planned hike could be delayed into 2016.
With the labor market continuing to tighten, however, the Fed may gain confidence in the eventual return of inflation and take action to begin normalizing interest rates, even before the definitive appearance of rising prices.
Many analysts anticipate the rate hike beginning later this year.
What actions should business owners take now to account for a future with higher interest rates?
When interest rates rise, the cost of borrowing money also rises. So, if your business is credit-dependent, you may want to factor in an increase in costs.
Part of your consideration should be the impact on your customers and vendors — will you have to pass along some of your increased costs via higher prices? How will that affect sales and receivables? Try to think about how you might handle a change in customer purchasing behavior; how might that affect your business?
Ultimately, the impact of higher rates will vary from business to business, but you’ll want to think through all the potential implications for increased costs and how they might affect your day-to-day operations, as well as your longer-term goals and strategy.
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