What’s Next for Interest Rates?

If you’re not sure, don’t feel bad—the Fed isn’t sure either. Here’s a guide to the possibilities.


On August 9, the Federal Open Market Committee (FOMC) halted a two-year tightening campaign and held the federal funds rate at 5.25%. In its formal statement announcing the pause, the FOMC indicated that any future increases would be “data dependent”—in other words, they need to wait and see.

What kind of data will they look to in the coming weeks? Their statement suggests the following data points will be important:

Data That Could Suggest More Tightening
Data That Could Suggest Holding

At 2.7%, core consumer price index ( CPI) is higher than the FOMC’s inflation-fighters would like.

Resource utilization rates are high and could contribute to more inflation.

Consumer spending remains robust.

At 2.5%, second-quarter gross domestic product ( GDP) growth is below the sustainable 3% - 3.5% rate.

Near-record oil prices and international instability weigh on the consumers’ psyche.

A cooling housing market has limited refinances and thus decreased accessible money for future purchases.

The Case for Holding Rates Steady

Consumer activity is 70% of GDP. While consumers have continued to spend, data suggests that future spending may be inhibited on account of multiple trends. First, housing markets are cooling; slowing home-price gains and higher borrowing costs are making it harder for homeowners to extract equity from their houses, thus affecting consumers’ discretionary spending. Secondly, consumers are reeling from near-record oil prices and the effects of international turmoil, weighing on their confidence and general outlook of the economic future.

The Case for Another Rate Increase

While economic growth is currently below its sustainable rate, the Federal Reserve continues to monitor upward inflationary pressures that could have an adverse effect on the economy. Raw materials and processing costs are rising, and manufacturers have signaled their intent to raise retail prices, thereby passing the costs along to the consumers. However, recent reports indicate that consumer-purchasing behavior is not slowing, providing a further impetus to check inflationary trends.

The Implications for Credit Unions

Unfortunately, neither scenario suggests a rosy interest rate environment for credit unions. A slowing economy could cause the yield curve to invert, putting more pressure on the net interest margin. On the other hand, the current flat yield curve could persist if we are in for more of the same economic environment.

Some questions that credit unions can address as they work through this challenging period include:

  • Is there any fat in the operating budget?
  • Are there leverageable cooperative opportunities that would increase revenue or reduce expense?
  • Are there pricing adjustments that could help?
  • Are there new lending opportunities that can increase overall loan yield?
  • Are all investments pulling their weight?

Although the future is uncertain, the possible scenarios are largely clear. An assessment of how the credit union will perform in each major scenario can help establish a set of tactical plans for navigating through the challenges.

Go beyond the interest rates and gain perspective on the credit union industry's performance at mid-year. Join us for Callahan and Associates’ complimentary Mid-Year Trendwatch Call. This event is a way to gain perspective on credit union data and macro trends.




Aug. 21, 2006



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