Putting Your Institution’s Best Foot Forward for a Lower-Rate Environment
Sponsored content by BOK Financial Capital Markets, a WBA Gold Associate Member
By Kent Musbach, senior vice president, and Marc Gall, senior vice president and asset/liability strategist, BOK Financial Capital Markets
After four years of hiking rates and then keeping them high, the Federal Reserve has now started lowering rates, hitting the ground running with a large cut of 50 basis points (0.50%) in September. As rates continue to fall, it’s important for management teams to understand how lower rates will impact their institutions’ income statements and to take steps to better position themselves for the even lower-rate environment likely to come.
Past, present and future conditions
First, let’s consider where we are now and how we’ve gotten here. Over the past few years, federal and consumer spending have been driving economic growth, despite higher interest rates. However, with many consumers now having used up all their excess savings from COVID—and then some—and also having record credit card debt, it’s questionable whether consumer spending can last at these levels. Meanwhile, unemployment has risen, which has raised concerns about weakening in the job market, even though unemployment is still relatively low on a historical basis. Given all these factors, the market is now forecasting a large number of Fed rate cuts, and some investors are wondering if the Fed can still pull off a soft landing or if a recession is in the making.
Preparing for 2025
Against this backdrop, each decision your management team makes in the last quarter of 2024 will be impactful for 2025. For instance, one important question to consider is when to begin cutting deposit rates. As financial institutions assess their ability and willingness to do so, margin and liquidity position will be important considerations. The news cycle also may aid decision-making this time around, as the Fed cuts likely will be well covered by the media. Consider reviewing rates against wholesale funding rates regularly and be prepared to adjust deposit rates frequently. Conversely, intermediate Treasury and wholesale funding rates have already fallen. To the fullest extent possible, attempt to hold loan rates higher for longer until the cost of funds begins to recede. Frequently, we see a race to the bottom on loan rates, so be prepared to fight for every basis point! This strategy may allow your institution to manage net interest margin from both sides of the balance sheet.
Understanding your interest rate risk position
With a significant inversion in the yield curve between Fed Funds and intermediate Treasuries, a non-parallel yield curve shift may be a more likely outcome. This may be led by the front end coming down more significantly than any changes in term Treasury rates that have already accounted for expected future rate cuts. If your institution has substantial risk around falling rates, you may be wondering if it is too late to manage your position given the inversion in the curve. What if you will benefit at some point from a steeper lower yield curve? Can you wait it out? With these questions in mind, you may want to take some proactive steps to hedge the risk of the market being wrong.
Investment portfolio conundrum
The current yield curve challenges investors to diversify risks. Although keeping large amounts of cash or short securities can generate the highest yield today, doing so could result in significant yield erosion if or when the short end comes down. Equally, the decision to lock into investments further out on the curve may give up immediate earnings for possible future benefit.
Instead, a balanced investment strategy could allow your institution to add a mix of securities that average a yield close to the Fed Funds rate with an allocation to call-protected assets. We urge management teams to consider the trade-off of investing in only the highest yield options compared to the potential benefits of adding assets with call protection that could result in an unrealized gain when the Fed lowers rates further.
Finally, it’s important to keep in mind that repeating the past is unlikely, but it’s still essential to learn from it. Understanding the choices that your institution made and then making informed decisions for the future is how your institution can and will put its best foot forward.
Contact Information
Contact BOK Financial Capital Markets at 866-440-6514 to discuss the latest economic outlook and timely considerations. We can help guide a unique, well-conceived strategy that considers many variables and potential outcomes.
Disclosure
The opinions expressed herein reflect the judgment of the author(s) at this date, and are subject to change without notice. The information provided has been obtained from sources believed to be reliable, but not guaranteed. Forward‐looking statements contained herein are based on current expectations and the economy in general, and are not guarantees of future performance. Likewise, past performance is not a guarantee of future results.
BOK Financial® is a trademark of BOKF, NA. Member FDIC. Bank dealer services offered through BOK Financial Capital Markets, which operates as a separately identifiable department of BOKF, NA. BOKF, NA is the bank subsidiary of BOK Financial Corporation. Investment products are: NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE
