Rate Hike Has Less Effect On Credit Unions

With less money in short-term investments, the increase in the target fed funds rate will have less effect on credit unions.

 
 

For the fifteenth straight time in as many meetings, the Federal Open Market Committee (FOMC) raised the target fed funds rate by a quarter point to 4.75 percent. This means that income earned on credit unions’ short-term investments such as money market shares, certificates of deposit and other accounts will rise.

With this increase, credit unions should see growth in income received on the $46.8 billion dollars they hold in cash and cash equivalents. This will result in an additional $88 million in investment income for the rest of the year.

Less Effect Than Previous Years

Although this sounds like a lot of money, this rise in short-term investment rates will have less effect on credit unions’ financials than in the past. This is a result of credit unions keeping less money in cash and cash equivalents. Credit unions currently hold less than 28 percent of their investment portfolio in cash and cash equivalents, as compared to 38 percent in March 2001.

This change in investment portfolio composition, and consequently the duration of the investment portfolio, is not the outcome of credit unions reallocating money from cash to longer-term investments. Rather, this decline can be attributed to credit unions financing growth in their loan portfolios with funds previously invested in cash instruments.

What will the Fed do next?

The FOMC meets again on May 10. Fed funds futures show that investors are currently pricing in a more than 90 percent chance that rates will hit five percent by June, which suggests they are anticipating another hike in May—all this despite last week's milder-than-expected rise in the core Consumer Price Index, a key measure of inflation. Because economic growth remains above trend, some economists are now projecting that the FOMC will continue tightening up to 5.5 percent, before beginning to ease in 2007.
 

 

 

April 10, 2006


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