Whenever the Fed cuts interest rates, it makes big news. However, does the rate cut matter to your association? Absolutely. It can affect everything from budgeting to real estate decisions.
At the Federal Open Market Committee’s (FOMC) September meeting, they agreed to make their second cut of the Federal Funds rate this year. The Federal Reserve (Fed) now target’s a range of 1.75 to 2 percent for its benchmark interest rate. The recent interest rate cuts by the Fed have drawn considerable news coverage as it’s a significant change in tack from the direction the Fed was moving just last year. It is important for association executives to consider the impacts the interest rate cuts may have on their operations.
Let’s start by explaining what the rate is and how it’s used. The Fed uses the benchmark lending rate to help stimulate or cool down the economy. The rate also is used as the basis for numerous types of loans throughout the U.S. economy and has implications across the globe.
Hoping it would cushion the U.S. economy, the FOMC has cut the benchmark interest rate due to concerns about slowing global growth and trade tensions between the U.S. and China. Trade discussions continue to ebb and flow between the U.S. and China, and additional data points show the potential for recession abroad and in the U.S. The flurry of news items has sent stocks on a roller coaster ride, interest rates have fallen further, and the yield curve briefly inverted at the end of August, with the 10-year Treasury yielding less than the two-year Treasury. Inversion of these two bond maturities has preceded every recession of the last 70 years, according to U.S. News and World Report. Many economists currently expect the FOMC to make additional cuts to the Fed Funds rate at future meetings.
What does this mean for associations? Here are a few areas where rate cuts could have an impact, positive or negative:
Budgeting. The fact that the Fed has cut and may continue to cut the Fed Funds rate is a sign that the economy is not performing as well as expected. Association executives should keep this in mind when creating their next fiscal year budget. A cooling economy might reduce an organization’s ability to further grow membership or limit the number of individuals earning certifications. Attendance at the annual conference may dip. Does your organization have revenue streams that might slim if the overall economy loses steam? It is important to keep the potential for these changes in mind given the solid economic gains seen over the past decade. If your organization’s budget includes income from your investment reserves, you should consider reducing that number for the next fiscal year, given the decline in interest rates over the past eight months.
Investments. If your organization owns fixed-income investments, you have likely seen strong results from those holdings year-to-date. Moving forward, however, the expected return is not as high. Fixed-income performance is driven by two parts: the income the bond pays out, and the price appreciation or deprecation of the bond. This change in value is heavily driven by the movement of prevailing interest rates. When interest rates fall, bond prices rise, and when interest rates rise, bond prices fall. Given interest rates have fallen to such low levels, they do not have significant room to fall further. This limits their continued growth potential in the near term. Despite the more limited return potential, fixed-income, specifically investment-grade, bonds can and likely should continue to be part of your overall investment portfolio. That’s because they are a strong diversifier from stocks and can be a relatively stable investment providing capital preservation.
Credit line. If your organization uses a line of credit, it may be worth speaking to the financial institution you work with to see if a less expensive interest rate on that credit line is now available. Or you can shop around to see if another lender could offer a better rate.
Real estate. Given the significant decline in interest rates, if you own property and have a mortgage, you might have the ability to refinance at a lower interest rate. If you are considering buying a building, the decline in interest rates might make it more affordable and a better option than leasing.
FOMC cutting its benchmark interest rate has multiple implications. By preparing for the potential negative outcomes now, and taking advantage of the potential savings it presents, it can help position your association to continue to flourish.