What the Fed’s Interest Rate Decision Means for Your Small Business

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What Fed Interest Rate Decision Means for Small Business

Journalists and traders alike awaited the Fed’s decision in anticipation, only to find out that the Federal Reserve decided to maintain the current Federal Funds rate target of 0-0.25%. (See the official announcement from the Fed here).

So what does the Federal Reserve’s decision mean for small businesses?

Well, in the short-term, very little. Rates have stayed at current levels since late 2008, and haven’t been raised at all since June 2006. So it should be business as usual for America’s small businesses.

But what about if and when the Fed does decide to raise rates? First, let’s consider a little background information.

The Federal Funds Rate, according to Investopedia, is the target interest rate at which large banks (typically the most creditworthy ones) may lend money to each other overnight. Each bank must maintain a minimum amount of capital in reserve to be able to meet its daily debt obligations, so the overnight window allows banks with extra cash to share with banks that have too little cash, and then collect a small percentage in interest (0-0.25%) for their trouble.

The Federal Open Market Committee (FOMC), the Federal Reserve’s primary monetary policymaking body, sets the target rate based on their view of how healthy the economy is. Rates were initially slashed in the early months of the Great Recession in an attempt to stimulate the economy.

However, the reason why so many obsess over this rate is because it has a direct correlation with how much banks are willing to lend to businesses and consumers. As the Federal Funds Rate rises, the more expensive it is for banks to borrow money. To compensate for the increase in expenses, banks have to raise the interest rates on their consumer and business loans. This, therefore, makes it more expensive for consumers and businesses to borrow from banks.

It could be many years before interest rates return to pre-recession levels, but businesses with significant growth aspirations could begin to plan now. Specifically, small business owners can take advantage of easy access to working capital before rates do eventually rise.

For small businesses, this means trying to come up with a 5-year and 10-year plan that predicts future capital needs. If a small business owner foresees needing a major influx of capital, they may not want to wait the whole 5 or 10 years before rates rise because they will be forced to pay more in interest on their loans. Plus, forward-thinking businesses can also use the savings from lower interest payments to reinvest in the company.

Small businesses should also be aware that their partners and vendors may be left with less cash once rates go up, since they will all begin to owe more in debt payments. Eventually, that could translate into increased prices for various supplies and services, which should also factor into the 5 or 10-year plan.

There is no definitive guide when it comes to choosing the right time to get a business loan, so small businesses should consult with their banks and other lending partners before making a decision.

The next Fed meeting is scheduled for October 27-28.

Image courtesy of Stuart Miles at FreeDigitalPhotos.net


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