By Phil Lucas
Now that the year-end reporting is winding down, it’s time to buckle down and assess where we are and where we’re going.
Your Q3 ALM report probably highlighted the dramatic change the yield curve has undergone in the last six months. Each of our US Treasury tenors saw a trading range of a minimum 100 bps in variance and some as high as nearly 150bps. The lower end of the trading range happened when the Fed started kicking off its rate cut cycle and markets quickly priced in 7-8 rate cuts for 2025. Since then, the Fed has lowered the Fed Funds rate by approximately 100 bps, and prospects for future cuts are far less certain.
As a refresher, the Fed kicked off their rate cuts with a turbo charged 50 bps cut. That level of rate cut is typically reserved for troubled economic times. In his testimony, Chair Powell expressed strong confidence in the direction of the economy. The disconnect between the policy decision and the tone from the Fed led market participants to start pricing in a chance that the Fed was committing a policy error, possibly stimulating an economy that didn’t need it. As a result longer term rates started to lift and have largely continued to climb since. In addition, recent jobs reports have come in better than expected and inflation reads have largely been hotter than expected. While there appears to be less concern around run-away inflation, many market participants are starting to digest the current economic metrics as the new normal, with inflation trending at around 3%, a Fed Funds rate closer to 4%, and longer-term rates closer to 5%. Inflation prospects were perhaps aggravated both by the last-minute spending directed by the outgoing Biden administration as well as the uncertainty around some of the more aggressive economic policies of the Trump administration.
Now that there’s some steepness in the yield curve, we’ve compiled a list of strategic priorities to focus on in 2025.
Hold Less Cash
At the top of our list is we think every credit union should reassess their cash position. While overnight deposits are highly liquid and offer strategic flexibility, they now come with a steep opportunity cost. Lower balance tiers at many corporate credit unions already pay less than 4%, compared to CD yields closer to 4.5% and bond yields near 5.5%. We think it’s a great time to reposition the liquidity portfolio, bearing in mind the recent effort of many CUs to shore up liquidity sources from the FHLBs, Fed, and Corporates. You might consider pushing a portion of your typical cash position into 1–3-month CDs which count same as cash on the call report. Many liquidity ratios also include cash and short-term investments to include maturities in the coming 12 months. 6-month liabilities are a favorite of many issuers, and you may find favorable terms there.
Reduce Cost of Funds
Remember, the marginal cost to raise a dollar from an non-member source is 4 to 4.5%, and the risk-free investment rate is closer to 5.5%. We think credit unions will continue to be able to reduce cost of funds this year. One option is to roll down certificate rates. You may also consider reducing money market rates the Fed cuts anymore this year
Loan Rates
We’re hearing loan demand is slow so far this year, so it may not be the best time to be overly aggressive with loan rates. More competitive loan rates may not actually lead to higher loan volume. Instead, you could focus on reducing borrowing positions and normalizing the balance sheet. For example, you could roll maturing cash flows into high quality bonds that can be used as borrowing capacity for the next time loan demand is hot. If your credit union already has a low OPEX and a stable, low cost of funds, loan specials may be appropriate. Just make sure to keep a close eye on credit quality. Provision expenses continue to rise and it’s not getting any easier for our more sensitive members to repay their loans.