We’ve all been anticipating it, and now it’s likely to come down the pike this week. The Federal Reserve is set to raise the target interest rate to above the rate of inflation for the first time in the better part of a decade.
The Fed rate hikes have been happening gradually, steadily since 2015. The June increase will set rates at between 1.75 and 2 percent. This matches the inflation target and puts the real rate at about zero.
Some economists believe this should be the last hike or it might start to hamper economic growth, but other experts think we’ll see more hikes this year and in 2019. That would give us a federal funds rate at 2.75 to 3 percent by the end of next year.
What does a Fed rate hike mean for banks and CUs?
The Fed’s rate increase affects what banks and credit unions charge each other for loans, and that increase, in turn, translates to higher rates within the bank on things like credit card balances and car loans. When the Fed raises its rate, banks follow suit and raise their prime rate.
Banking’s profitability increases as the rates increase because it ups the yield on cash holdings. But for other financial products banks are offering consumers, it gets more complicated.
Credit cards, HELOCs, adjustable rate mortgages
These types of products will get more expensive for consumers. Interest on credit cards will rise. ARMs are modified once a year, but when it happens, consumers will see an increase in their monthly payments. Banks may see more consumers taking out personal loans to consolidate credit card debt when rates get too high.
There’s an up-and-down possibility here. The cost of auto loans will rise with the rate hike, but that can create a ripple effect. If car loans are more expensive, people may put off buying a car. Less demand for cars could lead the price of the car itself to fall, creating even more demand for the loans. It’s hard to project exactly what will happen with this product.
It would stand to reason that customers would be hesitant about taking out loans in a rising interest rate environment, but, the opposite can happen. Rising rates signal a strong economy. Optimism takes hold and both consumer and commercial loans can see a surge, as people and businesses lock in loans before rates spike again.
This hike could inch mortgage rates to 5 percent by December, some analysts predict, but this could lead to lower profits on mortgage loans for banks. When rates are low, banks can offer low rates to borrowers and then pay for that mortgage by selling bonds to investors at a low rate of return. This interest spread boosts profits. But as rates have risen, and threaten to continue to rise, that interest spread decreases.
Banks can expect consumer demand for CDs to rise, especially short-term CDs. But beware of this one. Internet banks notoriously offer higher rates than brick-and-mortar banks, luring customers away.
Another cycle can happen here. Rising rates will lead to rising profits on bank investments. Investors will take notice, and soon the stock value increases. This, in turn, can lead to higher credit ratings for banks, making it easier to borrow and lower rates … which then leads to even more stock value gains.
Higher risk tolerance
All this activity, combined with a stellar job market and a strong economy, can lead banks to rethink their risk tolerance when dealing with customers who may not have perfect credit. That’s because, hey, they’ve got jobs and the economy is good, leading banks to believe they can make their monthly payments.
These are just a few ways the Fed’s rate increases can impact banks. Although some experts are predicting this will be the last hike, it’s also possible for rates to increase through next year. Stay tuned.