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On rate hikes, slowly but surely is the preferred route


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On rate hikes, slowly but surely is the preferred route

Kevin Dobbs is a senior reporter and columnist. The views and opinions expressed in this piece represent those of the author or his sources and not necessarily those of S&P Global Market Intelligence.

After a year-long wait, community bankers and nearly everyone else paying attention expect Federal Reserve policymakers to boost interest rates when they culminate their final meeting of 2016 this week.

Fed officials in recent weeks have sent no signals to discourage thinking that they will on Dec. 14 lift their benchmark rate by a quarter percentage point to a range of 0.50% to 0.75%. Policymakers have pointed to GDP growth and a solidifying job market as key elements of a strengthening domestic economy that can absorb a rate increase. Employers have added an average of about 180,000 jobs per month so far in 2016, helping to push the unemployment rate below 5% and to a level many economists view as healthy.

The federal funds rate typically influences what banks charge borrowers. When lenders can attach higher rates to credit products, they often earn more in interest income.

But even after the much-anticipated Fed move, uncertainty looms amid a change in the White House and global economic choppiness. That makes what comes after December of even more interest to bankers who, while pining for a return to a normal environment after years of ultra-low rates, want the increase to happen in a consistent fashion free of sudden surprises.

"You always have to worry about precipitous change one way or the other," Christopher Cole, executive vice president and senior regulatory counsel for the Independent Community Bankers of America, said in an interview. Sharp upward surges in interest rates, he noted, could catch managers of bank investment portfolios off guard, and dampen loan demand. Borrowers, he said, can absorb moderately higher rates as an economy improves, but a rapid acceleration could make loans too expensive for many, leaving banks with fewer customers.

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Against that backdrop, ClearView Economics President Ken Mayland said banks are eager for clear signs from the Fed on what looms in 2017. Bankers want to know if the Fed is most likely to carefully but consistently bump up rates, as policymakers have foreshadowed to date. This would allow bankers to plan ways to capitalize on the lending front, and also to brace for any needed changes to their stock and bond portfolios as well as their deposit bases, he said.

Following this week's meeting, Fed officials will release updated projections on the economy and interest rates, as well as a statement summarizing their current collective view. When policymakers last released such projections, during the third quarter, they laid out a median forecast of two rate bumps of 25 basis points in 2017, followed by three in 2018.

That is the gradual but steady path that most community bankers could navigate well, William Dunkelberg, an economist and chairman of Marlton, N.J.-based Liberty Bell Bank, said in an interview. He said he and many bankers would even prefer a moderately faster rise in rates.

Additionally, Dunkelberg said, a clear upward trajectory on rates would signal to business owners that the Fed is at last genuinely confident in the U.S. economy. He said the Fed's reluctance to move on rates in recent years has sent a message of doubt and discouraged businesses from taking risks and borrowing to invest in growth. That in turn has held economic expansion and loan demand in check, he said.

"But if we can finally normalize on rates, I think more of these owners will have confidence to move off of the sidelines," Dunkelberg said. When it comes to rate increases, he emphasized that the ideal is to methodically move back to "normal." If this happens and the cost of loans rises moderately, he added, businesses are likely to borrow and invest to capitalize on economic expansion.

But it should be noted that, when it comes to the Fed and rates, nothing is certain. Policymakers last lifted their benchmark rate in December 2015. It was the first time they raised rates since pushing them down near zero in the aftermath of the 2008 financial crisis. Following that last increase, Fed officials at one point projected they could raise rates four times in 2016. But they held off early in the year in part because of economic fragility in parts of Asia and Europe and later as the U.S. presidential election drew closer.

Now, with political newcomer President-elect Donald Trump set to take over the White House in January, some observers say it is difficult to gauge how the new administration will influence the economy because Trump has yet to clearly outline how most of his policies would work. Meaningful change could take years, forcing the Fed to move more slowly than anticipated.

Others say that Trump's broad goals of reducing taxes, ramping up spending on infrastructure and deregulating businesses, including banks, could result in a burst of economic growth, requiring the Fed to accelerate rate hikes in order to keep inflation in check.

Either of those scenarios could cause worry for community banks and reintroduce the heightened uncertainty that lenders and their customers loathe.