Conventional wisdom says that interest rate increases are bad for the LBM industry, but there are a host of reasons that the modest rate hike announced Wednesday, Dec. 14, should be a positive. Over the past year, we’ve noticed possible fear in the voices of LBM industry participants when they asked us when we thought the Fed might raise interest rates. The Federal Reserve’s rate setting committee now has answered that question by voting to raise its benchmark interest rate by a quarter point, nudging it to 0.75% from 0.5%. Kudos to the Fed for also signaling future rate hikes to let the market to begin pricing in those future changes now.
The case for seeing rate hikes as a negative is easy to make. An interest rate hike typically pushes down stock market prices in the short term, since stock prices theoretically represent the present value of all future cash flows of a company. Also, higher interest rates mean higher borrowing costs and increased cost of doing business for companies across all industries. For the LBM industry, when the interest rate–or price–of a mortgage increases, it is to be expected that demand among home buyers for mortgages should decrease.
These factors deserve consideration, but there are even more reasons that higher rates should be a net positive signal for the economy. The Fed’s willingness to increase rates is a sign that the economy is doing well and that a recession isn’t imminent. Higher interest rates give lenders an increased incentive to make loans, and given the fact that loan availability for manufacturers, distributors, builders, and consumers has been less than optimal over the past two years, increased lending is most welcome. To overcome resistance to higher borrowing costs, lenders will loosen lending standards. Borrowers who wish to avoid these higher interest costs will have an added incentive to secure a mortgage now, in advance of coming interest rate increases.
Bond investors are similarly sensitive to low interest rates. Since they receive a paltry return when rates are close to zero, they may be unwilling to invest in new bond issues. Interest rate changes lead to bond price movements in the opposite direction. When interest rates rise–and at these levels they can do nothing but rise over time–bond prices fall. Thus, when low interest rates prevail, bond investors fear a loss of principal, adding insult to the injury of low returns.
Last but not least, gradual interest rate increases over time will return to the Fed a critical tool that was taken from it when rates approached zero: future interest rate cuts. If rates don’t climb to a reasonable level by the next slowdown, the Fed will be unable to cut rates to spur the economy. Dialing in all of these factors, we have to see yesterday’s rate hike as a net positive for our industry.