Key economic indicators have strengthened from their lows during the COVID-19 recession in 2020. As the economy strengthened, inflation became an issue. Currently, inflation is at a multidecade high. In response, the Fed has signaled that they will begin raising interest rates in 2022.
A rising rate environment can create new challenges for many businesses, especially in interest rate sensitive sectors, but it can also create opportunities. That’s why business leaders should look to make the most of rising interest rates.
Where are interest rates headed?
Since the COVID-19 recession in 2020, both economic output and employment have improved. However, inflation has reached a multi-decade high. In light of the positive economic indicators and persistent inflation, FOMC members are expected to raise interest rates multiple times in 2022. The first of these rate hikes is expected at March’s FOMC meeting. By the end of the year, FOMC members forecast a Fed funds rate of 0.9%. Market expectations put the year-end rate somewhat higher, predicting a Fed funds rate at or above 1%.
Longer term, the Fed is expected to continue tightening monetary policy for the next several years. According to the most recent economic projections reported by FOMC members in December, the median projection for the Fed funds rate in 2023 was 1.6% and was 2.1% in 2024.
Steps Business Leaders Can Take to Prepare for Increasing Interest Rates
While rising rates are generally seen as a way to slow growth, there are several steps that business leaders can take to insulate themselves from the harsh effects of rising rates while also capitalizing on the opportunities they present:
Businesses Can Prepare for Higher Rates by Taking Advantage of Current Low Rates
As interest rates begin to climb, the cost of financing will likely increase. So, businesses that have been planning to finance a large purchase or acquisition should consider moving forward with the purchase while interest rates are low.
Businesses Can Prepare for Higher Rates by Reviewing Variable Rate Loans
In addition to taking advantage of low-rate loans for planned purchases, businesses should evaluate the risk associated with any variable rate loans they currently hold. This is because, in a rising interest rate environment, variable loans can be a significant and sometimes overlooked source of risk.
To evaluate their current debt, business leaders should review the terms of any variable loans to determine how much rates could increase, how much that could cost in additional interest, and how often increases could take place. Variable interest rate loans that allow for multiple rate increases or have rate caps that are much higher than the current rate generally carry the most risk.
Some variable loans contain the option to convert to a fixed rate. Converting now, while interest rates are still low, could save money in the long term. For variable loans that do not contain a conversion option, businesses should weigh the pros and cons of replacing those loans with fixed rate loans to capture the current low rates.
Businesses in Interest-Rate Sensitive Sectors Can Prepare for Lower Sales
Businesses whose products are sensitive to changes in interest rates, such as large ticket items that consumers typically finance, can anticipate lower sales as interest rates rise. In response, businesses in these sectors may consider slowing production to avoid manufacturing excess products. In addition, business leaders can increase advertising and work to improve sales techniques early in 2022 to capture more market share and counteract slowing sales.
Businesses can Prepare for Higher Rates by Preparing for a Stronger Dollar
When rates go up, the value of the dollar can increase against other currencies. For businesses that source their materials from foreign countries, this could mean lower prices on imports. On the other hand, businesses that sell their products in foreign markets could receive less money from export sales.
Depending on their sourcing strategies and target markets, businesses could have differing responses to a stronger dollar. Those whose inputs cost less when the dollar is stronger, could see higher profit margins. For businesses with international sales, leaders may want to consider raising prices to account for losses during currency conversion.
Businesses can Prepare for Higher Rates by Increasing their Cash Reserves
As interest rates rise, some essential expenditures could cost businesses more. Things like buying and renting property or equipment could become more expensive due to increased borrowing costs. Additionally, as inflation has increased, wages have gone up as well. This means that businesses could have to pay more to recruit new employees and could have to increase wages to keep current employees. To prepare for these higher expenses, businesses should consider increasing their cash reserves.
When businesses increase their reserves in response to higher prices, their operations are less likely to be disrupted in the short term. Also, by relying on cash reserves to meet price increases, businesses can reduce the probability that they will have to borrow funds at the higher interest rates to keep their businesses afloat.
Businesses Can Capitalize on Higher Interest Rates by Optimizing Cash Reserves
Another positive side effect of businesses increasing their cash reserves is they will generally pay more in interest when market interest rates rise. By investing in interest rate sensitive products, businesses can take advantage of higher rates by earning more on their cash reserves. But remember, not all deposit accounts are created equal.
With an American Money Market Account™ [AMMA™] from our company, the American Deposit Management Co. [ADM], businesses can rest assured that all of their cash reserves can be covered by FDIC / NCUA insurance, regardless of the amount, and earning a competitive return. That’s what we call smarter cash.
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AMMA™ provides access to the ultimate protection for business cash reserves, FDIC / NCUA insurance. We accomplish this by spreading deposits across our nationwide network of banks and credit unions so that businesses can achieve full protection with a single account and a single monthly statement.
Additionally, the financial institutions in our network compete for deposits. This means that businesses can receive access to nationally competitive returns for their cash reserves. To get started, contact us today.
At ADM, we keep our finger on the pulse of new developments in interest rates and the banking industry. To stay abreast of these topics, visit our Insights page and follow us on LinkedIn, Facebook, and Twitter.