The Fed raised rates in September for the first time in more than three years, then held steady at its October meeting. But with inflation still elevated and further increases possible, a lot of business owners are now wondering whether to pause.
I understand the impulse. Between inflation, energy costs and a Fed that could move again, sitting tight feels prudent. Sometimes it is.
But waiting has a price that never shows up on the financial statements: the order you couldn’t fill, the customer who went elsewhere, the competitor who bought the equipment you were still thinking about.
Interest rates matter. They just shouldn’t be the first thing you look at.
Customer demand, expected returns and your competitive position should carry far more weight than a quarter-point change in borrowing costs.
Here are a few ways to keep interest rates in perspective.
Focus on the numbers, not the headlines
Picture a manufacturer adding a production line, or a construction company buying new equipment.
Customers are lining up, the added capacity is needed and the owner expects solid returns for years to come. Should that investment wait because borrowing costs might drop half a point sometime next year?
I don’t think so. If the project is expected to return 12% or 15% a year, it still looks good whether financing costs 5%, 6% or 7%, provided your cash flow can carry the debt.
The same logic works in reverse. If an investment only makes sense when borrowing costs are very low, you need to take a harder look at the numbers. A project that struggles at 7% financing may still be worthwhile at 5%, but you should understand exactly why that difference matters. Lower borrowing costs can improve an investment’s economics, but they can’t make up for weak demand or unrealistic projections.
Waiting for a better borrowing environment feels prudent, but it isn’t free. So, before you postpone anything, ask yourself one question: would a quarter-point increase really change what this project earns, or whether you can repay the loan? If the answer is no, interest rates shouldn’t be what drives the decision. It is also worth remembering that no one really knows which direction rates are headed. Don’t get caught betting on the direction of interest rates. Focus on pursuing high-quality investment opportunities and turning down the bad ones.
Today’s rates feel high mostly because of where we’ve been
Much of today’s anxiety comes from the record-low rates we had during the pandemic. Next to that, borrowing costs feel expensive. Over a longer stretch of history, today’s rates aren’t particularly unusual, even if they remain a meaningful expense for businesses accustomed to cheaper financing.
What makes this stretch hard is the pressure coming from several directions at once. Wages, energy, materials and other operating expenses continue to weigh on businesses. The impact varies by industry. Interest expense is one more cost of doing business, and an important one. But for plenty of companies, that pile-up hurts more than the interest line does. Some can raise prices and some can’t. If your sales are strong, you may be in a good spot to expand even at higher rates. If your margins are shrinking, holding onto cash may be the smart call, and there’s no shame in that.
You know your competitive position best. The Fed doesn’t.
Know where you’re exposed
When the Fed raises rates, a loan tied to prime usually gets more expensive almost immediately. Deposit rates tend to lag, though banks competing for deposits sometimes raise them faster than the Fed does. Community banks can be especially responsive to local competition for deposits. Still, most businesses borrow more than they save, so higher rates can be a net negative.
Make sure you know whether your debt carries a fixed or variable rate, or whether the rate can adjust during the term of the loan. Work out what another increase would do to your monthly cash flow. Keep enough cash on hand to sleep well at night and make sure the returns you’re projecting clear your cost of capital with room to spare.
This is also where a banker who knows your business earns their keep. Someone who understands your cash flow, your customers and your plans can help you determine when higher rates could become a problem.
Focus on what you can control
Where rates go from here depends on inflation, growth and energy prices. The Fed’s decision to hold steady in October doesn’t mean rates have peaked. If inflation sticks, more increases are possible. If it cools, the Fed may hold steady for longer. If the economy slows significantly, rates could move lower. Predicting the direction of interest rates can be difficult.
Focus on the factors you can control: How carefully you vet an opportunity, how tightly you manage costs, how you structure your financing, and how well you protect against the downside risks.
Rates will go up and down, and something else will always be uncertain. But a sound investment doesn’t turn into a bad one because the Fed moved a quarter-point. Don’t let the Fed make decisions that belong to you.
Patrick L. Ryan is the President & CEO of First Bank.
