Watching the Fed

Three years ago, at an AICC regional meeting, I was asked to make a presentation regarding current and projected future interest rate markets. At that time, our market projection at Equipment Finance Corp. was that rates would remain low for the foreseeable future, since there seemed to be little pressure for increased rates. I therefore stated our recommendation to continue to utilize LIBOR-based floating-rate debt for business financing.

The one caveat to that advice was my assertion to “watch the U.S. Federal Reserve” (“the Fed”), stating that once the Fed begins to raise interest rates, and the economy and stock market absorbs the same without ill effect, that would be the time to convert floating-rate debt to fixed-rate. Well, we now look to have reached that point.

In December 2015, the Fed began its attempt to increase interest rates. At that time, 30-day LIBOR, which had been at or below 0.22 percent for many years, rose to 0.45 percent, almost exactly equal to the increase in the Fed discount rate. After several starts, stops, and mixed signals, the Fed has now embarked on its stated sustained push for higher interest rates. The Fed has now increased its discount rate four times by 0.25 percent, or a total of 1 percent. As we forecasted, each Fed move has resulted in a corresponding rise in LIBOR, increasing from its low of 0.17 percent in December 2014 to approximately 1.22 percent today. This has resulted in a rise of more than 1 percent for all floating rate borrowing.

The present concern for borrowers is that the Fed has made clear its intention to continue these rate increases. During its recent meeting, the Fed announced its plan for two more 0.25 percent rate increases during 2017, plus three in 2018. Based on that information, LIBOR projects to reach approximately 2.5 percent by the end of 2018. Furthermore, if the obstructionists in Washington can finally be pushed aside and a business-friendly tax reduction package is adopted, it could push the Fed to move rates up at a more aggressive pace.

Fortunately, there is a way to insulate yourself from this future rate increase. Since the first Fed rate bump in December 2014, swap rates—the fixed-rate market index for fixed-rate loans—have increased only by approximately 0.2 percent while short-term rates have risen by approximately 1 percent.

The historically low short-term LIBOR interest rates were a huge benefit to commercial loan borrowers over the past several years. On the other hand, the Fed has clearly signaled that this favorable floating-rate market cycle has ended. The time has now come to lock in your borrowing cost at the still historically low three-, five-, seven-, and 10-year fixed rates available in today’s lending market.

This article was written by Ed Gargiulo.