On today’s show we’re talking about the latest guidance from the Federal Reserve regarding interest rates. Yesterday the Fed announced the result of their latest committee meeting. They reaffirmed their guidance on maintaining interest rates low for the next 18 months, and then they extended that guidance by another year until the end of 2023.
The Fed talked about the role for monetary policy which simply describes interest rates. The Fed has made it clear that simply lowering interest rates won’t do much to further stimulate the economy. Whether interest rates are 2% or 0% isn’t going to all of a sudden get people to run out and make new investments in The Fed chairman also spoke about fiscal policy. This is controlled by the Treasury department’s spending of money to stimulate the economy. Naturally the Fed has a hand in this as well because the treasury is empty and any spending requires the treasury to come back to the Fed with cap in hand asking the Fed to print more money. Right now, political wrangling has created a stalemate whereby the losers are those who are in need of financial help. The politics of an election have come ahead of helping a crippled economy. After nearly a month with little congressional progress on a renewed assistance package, the economy is in peril from lack of government action.
So interest rates are at historic lows. What do you do with that information? What decisions should you be making knowing that interest rates are going to remain low for some time to come?
As I see it, low interest rates may possibly reduce your income if you’re in the business of lending money.
But if you rely on debt to fund the growth of your business, then you have a series of decisions to make.
1) The best think you can do in this environment is reprice existing debt into a lower interest rate vehicle with as long a horizon as possible.
When you borrow money in an inflationary environment, you are basically shorting the dollar. You banking on those future dollars being worth less than today’s dollars. If your interest rate is, say 2%, and let’s say that inflation is running at 3%, then the debt is being devalued at a faster rate than what you’re paying in interest. The money is essentially free at that point. I believe we are at the cusp of free money for that reason. But even more important than shorting the dollar, refinancing the debt into a lower interest rate facility gives you stronger cash flow and makes your business more resilient to economic shocks. We are not out of the woods yet with the pandemic and all the economic side effects. Lowering the cost of your debt is just plain responsibility.
2) It’s tempting to go and secure additional debt to grow your business. After all, the debt is so cheap, it’s tempting to go get as much capital as possible to take advantage of the low interest rate environment.
But here is where you need to think carefully. What is the purpose of the debt?
Is it to provide a cash buffer for the business? Is it to fund a growth in the business that is based on verifiable sustained demand? Is the growth speculative?
In today’s environment of uncertainty, you want to be establishing clear criteria for how you make investments. When are you going to make incremental investments? Have you established a high bar for making investment decisions?
Investments are made within a context. That context makes a number of assumptions.
For example, in 2010 the context was a distressed market where assets could be purchased for 30-40 cents on the dollar. Today’s context isn’t fully known or understood.
For that reason, my guidance is that new projects need to be undertaken very carefully. New debt should first be used to reprice existing debt and improve cash flow.