This time last year we wrote about how the national and Central Oregon economy would shrug off recessionary predictions, the Fed would be measured in lowering interest rates in the face of ongoing inflation and that businesses in most sectors would do well in 2024.
Despite a persistent inverted interest rate yield curve, our forecast was dead on — U.S. GDP was never negative, rather it grew by 3.0% and 2.8% for the last two quarters reported the Fed only cut its rate only three times for a total of just 100 basis points; and businesses generally expanded over the past 12 months. It was the second time in the past 70 years that an inverted yield curve proved to be a false positive for recession. Why? There was just too much money still circulating in the economy from public spending in reaction to COVID-19.
In the year since our forecast, there has been further contraction of the federal balance sheet via quantitative tightening (QT) — decreasing the money supply, for example, by not purchasing U.S. debt (i.e., Treasuries) it had in the past. Since this time last year, the Fed has shrunk its balance sheet by nearly three-quarters of a trillion dollars. That’s a steady decline of liquidity in the economy, meaning less money for banks to lend, businesses to borrow, and consumers to spend. Despite the effects of QT, inflation fears (and reality) persist, which means that interest rates — another tool used to hold back economic activity, will likely see fewer decreases in 2025 than last year. Expect the Prime rate (Fed funds +3.00%) to see only 2-3 drops of .25% each in the year ahead, and potentially as much as 100 basis points in total.
Interestingly, rime rate decreases in late 2024 have precipitated corresponding increases in U.S. Treasuries rates, and that’s good news, bad news for borrowers. Prime rate lending includes business lines of credit, credit cards, HELOCs and mortgage lending. Treasury rate index lending is typically for machinery, equipment and vehicle financing, commercial real estate, and business acquisition loans.
There is no short answer to what is behind the inverse relationship with rates currently but suffice to say that U.S. Treasuries yields have many drivers. First, U.S. debt has a global market on which prices are set daily by supply and demand. There is also the role Treasuries play as a safe-haven asset for the world and as such are influenced by uncertainty related to inflation, growth, and geopolitical risk, the lower the demand, the higher the interest rate that must be offered in order to attract purchasers of a given tranche of public debt. Consequently, Treasuries rates are notoriously hard to forecast, but the predictions we have seen are for them to go yet higher in 2025, eventually falling back to levels about where they are today by year’s end. Keep in mind that we are near 18-year highs for the 10-year Treasury rate today.
Longer term, top economic forecasters predict that rates in general (including Fed Funds) will again be on the rise in 2026 through 2030 as inflation roars back. Inflationary drivers for the second half of the decade will be around energy costs, wages (aging workforce and labor shortages), transportation and higher taxes. These are key inputs for commodities, wholesale and retail goods, manufacturing, construction as well as the service and professional sectors. The punchline for business owners: to the degree your business can support new debt, and that new debt facilitates better cash flow with expanded facilities, increased market share, automation, efficiency improvements, or people, etc., now is the time to secure it.
As we look to the year ahead, businesses must navigate a landscape shaped by tighter monetary policy, evolving interest rate dynamics and persistent inflationary pressures. Community banks like Summit Bank stand ready to partner with local businesses, leveraging local deposits to provide the necessary funding for operations and growth in this ever-changing economic environment.
For companies considering expansion or modernization, now is a pivotal moment to act, particularly as borrowing costs remain historically favorable, particularly compared to projected rate increases expected later in the decade. By staying proactive, informed and adaptive, businesses can position themselves for resilience and success in 2025.
