The Federal Reserve's Fed Funds rate is expected to reach 2.5% by the end of 2016, according to the August NCUA Report.
As illustrated in the NCUA's graph shown at left (click on the graph to expand), Fed policymakers predicted short-term interest rates will begin rising at some point in 2015, with an average rate of 1% predicted by the group by year-end. The lowest rate predicted for 2015 was 0.25% and the highest was 3%.
If economic conditions remain robust, the group of Fed board members and bank presidents predicted the Fed Funds rate will rise to 2.5% by the end of 2016. The lowest prediction was 0.5% and the highest was 4.25%.
"The improving economy brings with it lots of positives for credit unions," NCUA Chief Economist John Worth said during the August Economic Update video cited in the NCUA's monthly newsletter. "But at the same time a sustained pick up in the general economy brings the potential for interest rates to rise."
Rising rates, in general, are good news for most credit unions, Worth said. However, institutions unable to balance loan demand, deposit ebb and flow, and an increased cost of funds might find themselves incorrectly positioned to adjust to the changing environment.
"As you know, NCUA is concerned that some credit unions are not well-positioned to navigate in a rising rate environment," Worth said.
What's more, he said, the faster economic conditions improve and the stronger the economy becomes, the more likely it is that rates will rise even faster and percent increases will be lager than first anticipated. Conversely, if economic improvement slows and key indicators such as unemployment and overall spending take a turn for the worse, the predicted rate-increase scenarios could slow and increases may be less than predicted.
Credit unions should prepare for both scenarios, Worth urged.
"What are the key takeaways here?" Worth asked. "First, don't ignore the consensus. Rates are likely to trend up and the yield curve is likely to narrow, according to forecasters. It's too dangerous to lock in an ALM strategy that only works if the observers are wrong." Worth also urged credit unions to assume a margin of error for all forecasters, no matter who they are. Rather than follow only one dictum or a single analyst point of view, credit unions should hedge their bets to accommodate various scenarios.
"A much better position is to craft strategies that allow your institution to be successful on a wide range of interest-rate outcomes," Worth said.
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