Fed Interest Rate Hike: Where From Here?

In December, the Federal Reserve hiked the federal funds rate by a quarter percent for the first time since the Great Recession. The Fed also discussed a series of additional interest rate increases in 2016. Does this move signal a bright, new era of economic growth and higher interest rates or will the American economy continue stagnating and having low rates? How do we make sense of the troubled Chinese stock market and its impact on our markets? How will turmoil in the Middle East impact oil prices? What should local governments be thinking about and doing as we attempt to understand our nation’s economic course?

The December federal funds rate hike has had little impact on the overall municipal bond market, and rates remain attractive for local governments with financing needs. The bellwether Bond Buyer 20-Bond Index decreased 40 basis points during the last six months of 2015, with 12 basis points of that decline occurring since the Fed rate hike. Although rates have remained low, additional rate hikes will put upward pressure on municipal bond rates, particularly for short- and medium-term maturities. State and local governments that have refinancing opportunities should move quickly to lock in savings. Debt obligations with rates that are as low as 4 percent will provide a significant level of savings. Bonds that were issued in the years just before the recession in 2004, 2005 and 2006 should be good refunding candidates as well as the Georgia Environmental Finance Authority and U.S. Department of Agriculture obligations closed during that period.

In addition to higher interest rates, improvement in the economy will invariably translate to higher rates of residential and commercial growth, greater demand for government services, and higher construction costs. Now is the time to address current capacity issues and move forward with projects in your capital improvement plan. Today’s low interest rates can be locked in and projects bid before construction costs escalate. With crude oil prices lower than they have been since the Iraq War, projects that require asphalt, roofing materials, PVC pipe, steel and other products impacted by the price of petroleum can be completed very efficiently.

As interest rates move up, the money sitting in your bank account will become an increasingly significant revenue generator. With increasing interest rates a likely scenario, local governments should invest in shorter maturity investment products to preserve the opportunity to obtain higher rates when they become available. This is a terrific time to become familiar with investment products that can provide greater returns than bank deposits. Securities issued by federal agencies and government sponsored enterprises, such as Fannie Mae and the Federal Home Loan Banks, are examples of authorized investments that can provide significant spreads over bank products. Chief financial officers and finance directors who become familiar with these types of investments now will be better prepared to maximize interest earnings. Those local governments that have not already done so should make implementation of a comprehensive investment management policy a 2016 priority.

In the current environment of economic uncertainty, financial market turmoil and geopolitical mayhem, sitting tight might seem like the right course of action. Although we are uncertain about what the future will bring, we do know that at some point our economy will grow, and that growth will bring about higher interest rates. The population, utility customers and tax bases of Georgia communities are beginning to grow again. Local governments that step up to take advantage of today’s low interest rates and prepare for a higher rate environment will gain a strategic advantage in the perpetual competition for quality jobs and growth.

Tony King, managing director, Kidwell & Company, Inc. (King also is a CSLF advisory board member.)