The Federal Reserve Board of Governors unanimously voted to increase the interest rate paid on reserve balances by 0.75% to a range of 1.5% to 1.75%, effective June 16, 2022. It is the largest increase by the Fed since 1994.
Over the past several months our blogs and articles have predicted that an interest rate increase was looming. When the Fed raised the interest by 0.5% in May of this year, we commented that the increase was not meaningful and that much larger increases were required to combat an inflation rate that was reported at 7%-8% at the time – but in reality was much higher.
Raising interest rates is a tool to fight rising inflation, which all Americans are feeling. The party in power probably would like to have staved off this increase until the midterm elections in November, as no party in power wants a weak or negative economy just before the midterms. But as more and more families are suffering the effects of the actual level of inflation, and the media is bringing the real level of inflation to the public’s attention, the Fed could not hold off any longer. So they instituted a 0.75% increase – with clear signals that more increases are to come.
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Possible Long-Term Effects
There will certainly be a substantial negative effect on businesses, including real estate and the stock market, as a result of the interest rate increases. To date, the economy has not shown how weak it really is. Based on interviews I conducted with several bankers as well as borrowers, banks are not being forced by federal auditors to deal with defaulted commercial loans. This situation was aided by the trillions of dollars from PPP loans and extended unemployment checks the government has printed and loaned or given away to businesses and individuals within the past year.
Two things are clear. First, the biggest bit of fake news we are now being given is that inflation is running at 7%-8%. Housing, gasoline and food are three of the biggest components in the average budget. Which of those three is running at less than double digits? Nationally, gasoline is up over 42% since April. Housing costs in regions like South Florida have doubled within the past year.
Second, we are facing a perfect storm of factors that will create a recession, or worse. These are the primary culprits:
- Inflation is out of control with no real end in sight.
- Interest rates will have to be raised far beyond what the Fed has done to date to effectively combat inflation.
- The effect of China’s “zero tolerance” policy toward COVID-19 has kept hundreds of millions of Chinese workers locked in their apartments for the past six months. These workers were not making the goods that we need to make our economy run. Within the next six months, when those goods will not be available at any price because they don’t exist, that effect on our economy will become all too clear.
As the impact of these economic changes affects an increasing number of families and businesses, more entities will experience financially distressed situations. We are already seeing companies and real estate investors and entrepreneurs experiencing a steady increase in distressed assets. Companies are moving from 30-day payables to 60-days, and now many are 90-days out and debt is mounting. As interest rates and inflation continue to rise, debt will also continue to be an issue for all business entities.
Clearly, the stock market is also under pressure as well, with the S&P 500 officially sliding into a bear market on June 13, just ahead of the Fed’s latest interest rate increase, and the Dow close to joining it the day after the rate hike was announced.
Steps to Consider
Business and real estate owners would be well advised to consider what the near future may bring to our economy and prepare for the inevitable. Now is the time to ameliorate distressed assets. When companies begin to accrue significant discrepancies between its collections vs. its debts, it is time to consult with a professional who specializes in reducing distressed assets early on to avoid having to fill chapter 11 down the road. Carefully assess your business as well as your personal cash flow.
Consumers and retired persons, as well as business owners and entrepreneurs, should consider working with a financial planner, tax professional or attorney who can assist in preparing for the impending recession before it arrives. Early preparation and liquidity seem to be cogent moves at this juncture.
The upcoming recession will not be a surprise to any of us. Now is the time to prepare for it.
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