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Mixed Economic Indicators Signify Now is the Time to Address Troubled Loans

The Federal Reserve Open Market Committee met this week to discuss its monetary policy for the period. In the press release issued after the meeting, the Committee stated that although the labor market remains steady and strong, the growth of economic activity that had been so strong in the fourth quarter of 2018 has experienced some slowing, based in part on indicators such as household spending and slower business fixed investment. Overall, inflation has declined over the past 12 months, largely owing to lower energy prices. As a result of this relative stability, the Committee announced that rates will remain unchanged not only for the short term, but also possibly for the remainder of 2019, saying that in light of current market conditions – general economic stability around the globe, muted inflation, and near-optimal inflation of 2 percent – “the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.”

Given that the statutory mandate of the Fed’s Open Market Committee is to seek to foster maximum employment and price stability, the Committee has decided neither to raise nor lower rates in light of current economic conditions. The Committee will maintain its target federal funds rate at 2-1/4 to 2-1/2 percent to support its goals and with a steady economy under the present rate structure, its reference to “patience” indicates an intention to allow the market to determine for itself which direction it will take over the coming months. 

In contrast, the yield curve, or spread between the 3-month and 10-year Treasury Notes on Thursday broke the longest-ever streak of being above 10 basis points. The last time the two notes were below that level was in September 2007, just before the Great Recession. Some economists see this as a sign of inversion, where long-term debt instruments have a lower yield than short-term instruments of equal credit quality, and a predictor of recession.

What does this mean for lenders with borderline loans? On the one hand, the Fed’s election not to lower the federal funds rate means underperforming businesses should not expect to see a flurry of spending to improve their circumstances, though on the other hand, those same businesses will not also face the burden of finding additional funds to pay towards increased interest on their debts. Although the Fed is being patient, the aforementioned preliminary sign of compression in the bond yield spread suggests that lenders should be working proactively to improve the health of their own portfolios, closely scrutinizing their borrowers’ financial reports to identify struggling businesses, exploring ways to address weaknesses, and developing exit strategies while rates are favorable.