As analysts’ commentary converges around late 2015 being the time to expect Fed action on interest rates, a new report from strategic consulting firm Tatum shows U.S. business owners are split on what an increasing rate environment could mean for profitability and performance.
The first-quarter 2015 edition of Tatum’s Survey of Business Conditions finds just about half (54%) of chief financial officers (CFOs) and strategic business executives feel it is likely the Fed-driven prime interest rate will reach 3.125% by the end of 2017. Researchers note that interest rates have hovered at or near record lows since the depths of the financial crisis—a largely unprecedented period of “easy money” policy that has coincided with strong stock market recovery.
As noted by Tatum researchers, increasing interest rates will impact businesses and investors in a wide variety of ways, positive and negative. More alarmist analysts suggest a rise in rates could shock markets grown used to rock-bottom rates and derail the ongoing recovery. Others feel a rate hike is long overdue and necessary to prevent asset inflation and another bubble-crash cycle.
In the financial services and advisory space, increased interest rates can be favorable for retirement clients relying on fixed-income products—so long as net portfolio volatility is kept in check as rates normalize and markets adjust. Defined benefit (DB) retirement plan clients are especially looking forward to higher interest rates. This client group has struggled since the financial crisis to maintain healthy funding levels, given that lower interest rates mean more dollars must be invested today to meet future liabilities. Lacking sufficient yield through traditional fixed-income allocations, pension fund clients have had to settle for lackluster returns or surplus risk-taking.
But it’s not just large pension funds that are closely tracking interest rates and their impact on portfolio strategies—defined contribution (DC) plan advisers are paying heed, too. Research published last year by Janus Capital group found more than nine in 10 financial advisers (93%) felt rising interest rates would be a critical client conversation topic to address in 2015. That report suggested interest rate changes will be both a challenge and an opportunity for advisers and their clients. One practice all advisers should consider, Janus researchers suggested, is to run some type of stress testing on commonly used client portfolio models to ensure there are no unexpected reactions to interest rate moves.
Looking to practice management, Tatum finds advisory companies could accelerate capital investments in the near term, perhaps pulling the trigger on a strategic acquisition or significant capital expenditure while rates remain low. Other firms could dial back on longer-term projects that will require additional financing later on.
Similarly, Tatum finds some companies inside and outside financial services expect to increase debt levels sooner rather than later, to take advantage of better rates and liquidity. Others will replace debt with new credit/equity arrangements or reduce their debt levels, Tatum notes. However, the majority of CFOs foresee no major change to their debt pricing structure or cash investment management strategies, should interest rates increase slowly and modestly, as intended by the Federal Reserve.
The Tatum survey also asked participants to reflect on trends over the past 30 days and share their predictions and projected business outcomes for the next quarter. CFOs from Tatum's partner network and external organizations alike report improved business conditions over the previous month, and the forward outlook remains positive even in the face of potential interest-rate action. Overall, 46% of Tatum partners and 47% of external CFOs expect that business conditions will improve over the next 60 days.
The Survey of Business Conditions is a high-level executive survey based on the aggregated opinions of Tatum's internal chief financial officer partners and external CFOs surveyed by the firm. The full findings are presented here.