The Federal Reserve is in the spotlight again this week with another interest rate hike in an attempt to crush the inflationary beast. Prices are rising just over 8% year-over-year, while wages are rising at an annual rate of 5%, a losing proposition for workers and consumers. The Fed has raised interest rates this year to slow spending. These rate hikes have led to higher mortgage rates, but consumer spending in general remains strong and that is a problem. The 10-year Treasury bond is now yielding 4%, the cost of financing federal debt is rising. The cost of small business loans has followed this rate for 48 years. Now historically low due to the abandonment of the 0% interest rate policy, homeowners paid an average of 19% for their short-term loans in the early 1980s. Now rates are 4% to 5%, but they rise as the Fed raises rates. So far, the percentage of owners complaining that they didn’t get all the credit they wanted and the percentage saying credit was their main business problem are historically low. But that’s likely to change as rates rise and the Fed stops buying Treasuries.
Small business owners are not very confident that these issues will be successfully resolved anytime soon. Asked about trading conditions six months from now, only 8% said “better”, while 56% said “worse”, among the lowest readings in the survey’s history (48 years). Expected sales are equally bleak, with 20% higher actual sales volumes and 40% expecting a decline. Only 4% thought the current period was a good time to expand substantially. In 2018, no less than 36% thought so. Remembering that small businesses produce about half of our GDP and employ about as much of our workforce, that doesn’t look very promising for the rest of the year.
From an investor’s perspective, if one can earn 4% risk-free by lending money to the government, lending money to fund small business expansion must provide a much higher return. to compensate for a higher risk of default on the loan (and similar loans). In addition, an investment project must offer a much higher return on the money invested (reduced costs, increased sales, etc.). A project that has returned 5% may be worth financing with a 4% bank loan, but not with a 6% loan. Higher interest rates reduce the number of profitable investment options. And for consumers, the cost of financing large purchases (cars, houses, etc.) is also increasing, which slows spending.
Thus, inflation is the main problem faced by small businesses today. The shortage of skilled labor comes second, as job vacancies and hiring plans are still historically high (consumer spending has not collapsed). Fed policy raising interest rates will dampen spending in many sectors and consumer spending will fall (this is the goal), especially as unemployment begins to rise. That’s the economic outlook for the next 12 months.