The last year there had been so much talk about whether interest rates would go up, when they would go up, how much they would go up, and what the impact of any increase would be.
In December, the Federal Reserve put the crystal ball gazing to rest when it raised the target rate for the federal funds rate to one quarter to half a percent. It was seen as the first step in an upward march that would extend into 2016.
While on the one hand, a rate hike was viewed as a sign that the economy perhaps was finally strengthening, consumers felt no reason to rejoice, mostly because they anticipated higher interest rates would hit them squarely in the pocket - be it credit cards, mortgages or car loans, and savers didn’t feel overly confident that the interest earned on their savings would improve significantly.
But higher interest rates are music to bankers’ ears.
"With a lower interest rate, there is normally a decrease in the net interest margin, so a lot of banks are actually hoping for an interest rate increase. An interest rate hike is usually a sign that the economy is doing well, which can translate into higher demand for consumers and even business loans, which also improves profits," explains David Bakke, a financial journalist with MoneyCrashers.com.
Truth is, banks’ net interest margins mostly have been nothing to brag about with the low, low interest rates of recent years and other factors. Net interest margins are the spread between a bank’s borrowing costs and lending rates. When this difference shrinks, bank profits suffer. It is estimated that bottom-of-the-barrel rates put a damper on bank margins by more than 27% over the last six years.
But rising rates don’t necessarily mean it’s time for banks to start celebrating.
"As a result of near-zero low interest rates previously, many consumers purchased homes using adjustable rate mortgages and banks gave their fair share of these loans. The problem is that as the Fed increases its interest rates, the interest on these mortgages climb as well. This increases the mortgage payments and makes it harder for consumers to fulfill their obligations. We may see foreclosures rise, which will again hit the banks," says Idan Levitov, vice president of trading at Anyoption.com.
"While the banks may make more money on loans with higher interest rates, the amount of loans they are likely to supply is going to decline. So essentially, the gains from higher interest are washed out by the lower number of loans that are likely to be taken out. As a result, the banks have been experiencing relatively flat movement, which will only trend downward if interest rates rise further," he predicts.
The news is sobering still, as the Fed left rates unchanged in January, clearly cooling its heels, after eyeing all the political and economic turmoil around the globe.
As for what the Fed will do come March, who knows? Maybe there will only be two rate hikes this year instead of four. Looks like we’re back playing the guessing game.