Growth Postponed: The Fed Rate and Its Impact on the Construction Sector

Yesterday, (March 16, 2016) the Federal Open Market Committee (FOMC) chose to delay an increase in the federal funds rate. This decision was based on uncertainties regarding growth in the global marketplace. Policymakers project that economic growth will be weaker than expected and inflation levels will remain low during 2016. Fed policymakers have adjusted their inflation forecast for 2016 to 1.2%, down from 1.6%. These factors have played a role in the decision to leave rates unchanged. Consequently, borrowing costs will remain favorable for commercial banks and businesses. However, favorable short-term interest rates will likely be short lived as the labor market continues to strengthen and the economy expands. In December of 2015, short-term interest rates were raised for the first time since the financial crisis from near zero to 0.25% with the intention of gradually returning interest rates to more normal levels. Over the course of 2016, the Fed will meet two more times to vote on future federal funds rate increases.

Pushback on future rate hikes is expected from investors and businesses that fear that economies abroad are too fragile for domestic businesses to expand. Weakening global markets not only slow the pace of domestic inflation, they also lead to volatile manufacturing output levels. Stakeholders dread that the rise in interest rates will cause domestic consumers and businesses to spend less. Despite such concerns from investors and businesses, the FOMC will likely allow domestic market conditions to determine the pace of future federal funds rate hikes, and projections indicate further growth of about half a percentage point by the end of 2016.

Should construction firms rent or buy?

The decision to leave interest rates unchanged will benefit domestic businesses that often make large capital expenditures. For example, firms within the construction sector finance or lease equipment, office space and other related overhead necessary to tackle construction projects. Because the cost of financing and leasing such capital is highly sensitive to changes in the federal funds rate, construction firms that rely on equipment financing can effectively budget for the cost of upcoming equipment purchases.

However, with higher interest rates on the horizon, equipment financing will become a less attractive option for construction firms in need of loans. IBISWorld forecasts that the price of equipment financing services will increase at an average annual rate of 5.6% from 2016 to 2019. Construction firms can leverage the availability of rental services to avoid greater up-front costs. Rates for equipment rental services, including earthmoving machinery rental, aerial lift rental, forklift rental and industrial truck rental, are projected to rise as well, but renting may still provide a more favorable option to businesses contending with higher interest rates. With rates on the rise, contractors and other construction firms reliant on financing for capital purchases should consider engaging in contracts now to hedge against steadily rising costs brought on by an increase in the federal funds rate.

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