In Janet Yellen’s address to the Executives’ Club of Chicago today, Chair Yellen signaled confidence that the Fed would continue with current expectations for three quarter point fed funds rate increases for 2017. She concluded her speech by saying, “…unless unanticipated developments adversely affect the economic outlook, the process of scaling back accommodation likely will not be as slow as it was during the past couple of years.”
Following today’s speech, Goldman Sachs increased the odds for a March rate hike to 95%, and it appears the equity and bond markets are fully expecting a March rate hike. However, it is important to keep in mind that the gradually increasing cost of interest in the economy will place more and more stress on consumers and businesses to service their debts.
For example, Commercial and Industrial loan delinquencies bottomed in the fourth quarter of 2014 at 0.72%. Since then, the C&I loan delinquency rate has gradually increased to 1.59%. Many commercial loans are floating rate loans tied to benchmarks such as LIBOR or the Prime rate, which move concurrently with increases in the fed funds rate.
The C&I loan delinquency rate has already doubled with only a 0.5% increase in the fed funds rate. With investors expecting another 0.75% increase in the fed funds rate for 2017, it will be very important to monitor the impact to loan delinquencies as the cost of servicing these debts begins to increase.
As an anecdote, I recently spoke with a large real estate investor who was looking to develop a commercial property. Embedded in their financial modeling of the property was a 5% rate of interest on their (floating rate) construction loan. Real estate investors across the US are building (and buying) properties based on a cost of financing that is going higher faster than most people anticipate.
Many businesses have become accustomed to low and stable interest rates, but as rates increase, stresses will continue to build as we are already seeing in the C&I loan delinquencies.
Disclaimer– This article is for informational purposes and does not constitute financial or other advice. Please consult with your financial advisor before making any investment decisions. Please read full disclaimers here.