A Move In Rates Has Hijacked My Budget. Now What?

How three possible rate paths could throw a curveball during the 2017 budgeting process.

The strategic planning season is upon us. Senior managers and the board will gather to set the course for the credit union for the next year and beyond. Then, it will be budget time.

Interest rates, and assumptions about them, will be a major determinant in the budgets for the coming year. And unless senior management holds a strong view about rates, most credit unions’ budgets will assume rates will stay the same or rise slowly. As of this writing, that is the odds-on favorite course.

By the time credit unions get down to crunching numbers later this year, things could look quite different. However, rates in 2017 will still be unknown, and credit unions will have to consider a variety of rate scenarios.

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SCENARIO 1: Rates fall to new all-time lows in 2017.

The possible trigger for this would be a meltdown in China, most likely stemming from a debt crisis there and followed by a serious recession.

Although the United States could weather a Chinese storm, the fallout of a Chinese recession could bring the U.S. to the brink of, if not into a full-blown, recession in 2017.

In this scenario, credit unions need to factor in a funds rate falling back to near 0% and a 10-year note rate of 1.25% sometime in 2017. For planning and budgeting sessions in 2017, start thinking ahead about how to survive negative interest rates.

Outlier rate paths will have different implications for credit unions depending on balance sheet and interest rate sensitivity.

SCENARIO 2: Rates rise more than expected.

The keys to this rate path emerging would come on two fronts. On the economic front, worries about China fade, Europe performs better than expected, and the U.S. stock market starts to cook again after a sluggish first half of 2016.

The more important front, in my opinion, would be inflation. Inflation begins to rise slowly, turning expectations completely around. The bond market has been living on a world view of disinflation/deflation. An abrupt change in this view would cause some turbulent times in the over-leveraged bond market, and rates would move erratically higher.

Credit unions would need to test their 2017 budget forecast on a funds rate of 2.0-2.5% and a 10-year rate close to 4.00%.

SCENARIO 3: Yield curve inverts.

If longer-term rates fall below shorter-term rates, credit unions can book a ticket on the Recession Express. An inverted yield curve has a perfect record in predicting recessions. An inverted curve at higher rates would be far less painful than an inverted curve at today’s low rates, but the inverted curve is no friend of FIs.

These outlier rate paths will have different implications for credit unions depending on balance sheet and interest rate sensitivity.

In the low-rate environment, the pain might not be too bad for those in a borrowing position and strong loan demand. In the high-rate environment, the picture is muddier.

Some cash-heavy credit unions will be able to feast on higher rates on assets. Loaned-out credit unions might be challenged to raise funds in a more competitive environment for deposits. Short-term funding costs could rise higher and more quickly than expected.

This is a short start to a long list of considerations when analyzing balance sheet and earnings potential. Hopefully by budget time you can safely eliminate one or more of the outliers, but don’t let your guard down.

Dwight Johnston is the chief economist of the California and Nevada Credit Union Leagues and president of Dwight Johnston Economics. He is the author of a popular commentary site and is a frequent speaker at credit union board planning sessions and industry conferences.

July 4, 2016

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