Interest rates are on their way up. After keeping rates at historic lows for several years, the Federal Reserve launched a series of upward adjustments toward the end of 2016, and announced another hike in June 2017.
Finance experts are frequently asked to predict where rates will go from here. However, the answer is not as obvious as one might think.
Rates that Go Up Must … Go Up More?
Because of the Federal Reserve’s recent hikes, Mike Wiedemer, Senior Vice President at First American, believes there is a “general expectation that rates are likely to continue rising in the years ahead.”
But expectations are not guarantees, and most financial executives will admit that even if an upward trend seems likely, there is no way to predict with any certainty that interest rates will definitely continue to rise.
Why the hesitation to make a bold prediction, despite evidence to support it? One reason is the uncertainty surrounding the economy: Will tax reform get passed? What will unemployment and inflation rates look like? Will our global trade policies change?
The winds may be changing, but it is impossible to say right now from which direction they are blowing.
In other words, because so many issues influence interest rates, predicting future trends is difficult for even the most seasoned finance industry professionals.
How Rising Rates Affect Business Decisions
The more salient question, therefore, is not, “In which direction will interest rates go,” but rather, “If interest rates continue to rise, how will that impact my business?”
With this perspective, interest rates become one of many factors business leaders must weigh when making strategic decisions – sharing space with concerns over regulations, customer demand, technology, tax incentives and more.
One area most heavily impacted by the interest rate environment is capital investments. If interest rates do go up, the cost of borrowing will become more expensive. Organizations may therefore seek to protect their investments today and lock in rates while they are still low.
Fortunately, businesses have several solid options.
“When it comes to the economy, there are a lot of things up in the air right now, but interest rate risk doesn’t have to be one of them,” said Mike.
He suggests businesses consider three strategies for eliminating interest rate risk in an uncertain environment:
Take on fixed-rate debt. If interest rates continue to rise, companies that borrow money through debt products may benefit from fixing their debt cost rather than having it float with the current rate in a variable-rate product.
Lock in rates now. If a business knows it will need to make a large purchase in the next 12 to 18 months, the business can lock in today’s rates for tomorrow’s capital purchase. This affords protection against future rate increases, albeit at a premium cost.
Look for a true lease (i.e., a Fair Market Value lease, or FMV lease) rather than a financed lease (i.e., a Dollar Buyout lease). As interest rates rise, so does the cost of capital. It may be more advantageous for a business to rent rather than buy equipment. As Mike explains, “Consider paying for use instead of paying for ownership.”
While it does seem that interest rates are trending upward, only time will tell what path they will ultimately take. That uncertainty makes selecting the right financing strategy even more important. And yet, one thing remains clear: The right products and borrowing structures exist to help businesses meet their long-term finance needs while managing a complex and evolving interest rate environment.