Following financial news can feel like a deluge of information on a daily basis. Some want to hide their head under a pillow when the front page of CNBC.com delves into ag commodity prices, oil prices, Federal Reserve meetings and the stock market. What is a credit union in the Dakotas supposed to make of all these things going on?
My job is to filter out the noise surrounding extraneous information, so let me help you make sense of our dynamic world. One thing that will impact all credit unions is the Federal Reserve’s intention to raise interest rates.
What does the Fed raising rates even mean? The Federal Reserve, who lends money to credit unions and banks, can lend cheaper than everyone else in the country. If they increase the interest rate at which banks and credit unions borrow, then lenders will need to charge a higher rate on loans also to cover the increased cost. Even if your credit union doesn’t borrow money through the Fed, you could feel this impact of increasing rates. When banks and CUs rely less on the Fed, they rely more on depositors, and will try to fund more assets with deposits. This gives depositors the ability to demand higher interest rates too. While we have not observed this yet, it is a real possibility as the Fed raises its rates higher.
Another situation you will witness with the Fed raising rates is how it will impact your securities portfolio. When interest rates go up, bond prices fall. This is because new bonds can be issued at better, higher rates, and old bonds are less desirable, since they are stuck at lower rates. The longer the term of your bonds, the greater you will see a devaluation of their price. Therefore, it may make sense to avoid buying bonds, especially long-term bonds, unless those bonds have some variable rate features that allow for the rate to adjust.
This brings us to the last important point to consider, which is the effect of having long-term fixed rate loans. Just like it is more desirable to have bonds that can adjust their rates, it is highly desirable to have long-term loans with adjustable rates too. Going back to the concern that deposits can become more expensive, this becomes a serious issue if you can’t change the interest rates on loans. Your credit union funds operations by charging more for loans than it has to pay for deposits. If the interest rate on loans and deposits become closer together, the credit union has less net income to fund operations.
To summarize, if the Fed is raising rates, you could eventually see your deposit rates rise, and you will see the value of your investments drop! Try to avoid investing in both bonds and loans in the long-term, unless the rates are adjustable. And be aware, the Fed wants to raise rates, and will do so if there is positive economic news. Be prepared!