By Matthew Jacobsen, VP

In 2017, credit unions continued to see solid loan, share, and membership growth. Growth in these areas has been consistent since the last recession, and loan growth has slightly picked up the pace in recent years. Loan portfolio credit performance continued to remain strong with overall delinquency rates and charge-offs remaining at healthy levels.

On a percentage of the total loan portfolio basis, total delinquencies have remained relatively flat in the past several years and total net charge-offs have increased slightly from the lows seen in 2014 and 2015. The increase in net charge-offs was confined to consumer loan categories including certain vehicle loans and credit card loans. Given the above, credit union ROA was relatively strong in 2017, particularly given the low interest rate environment.

2017 also marked a new all-time high for household debt, and it continued to increase into the year-end. Aggregate household debt balances increased in the fourth quarter of 2017 for the 14th consecutive quarter. However, as a percentage of consumer incomes, it is still lower than the 2007 peak. Nonetheless, how much more can consumers borrow in 2018?

Some economists argue that given the expected economic growth, low unemployment, and wage growth, credit unions should expect to see a continuation of solid loan growth in 2018. However, if longer term interest rates are rising and “pent up” auto demand having now possibly been alleviated, this may not be as sure a forecast as many are expecting.


In recent months, many economists have increased their economic growth outlook for 2018. The minutes of the January Federal Open Market Committee (FOMC) meeting showed that officials saw a stronger economy than at the end of 2017.

In February the Federal Reserve gave its semi-annual monetary policy report to Congress and saw broad improvement in the U.S. economy and pointed to a pickup in inflation toward the end of last year. Conceptually, when economic growth is expected to strengthen, particularly in a tight labor market, inflation expectations also increase, and interest rates rise.

However, the central bank also continued adhering to its previous view that inflation is likely to remain at or below its 2% target in 2018. The FOMC’s “preferred” PCE index stood at 1.7% in December.

The Federal Reserve continued to note that even as the labor market remains very strong, labor costs are not increasing very rapidly. Labor cost increases are generally a key driver for overall higher inflation. The Federal Reserve further noted it’s possible that technological and other changes are contributing to low inflation worldwide.

As economic growth is forecasted to remain positive and potentially accelerate in 2018, some are forecasting that this will finally spark inflation and lead to higher long-term interest rates and potentially even an acceleration in rising interest rates.

However, this has been many economists’ narrative for the past several years and it has yet to come to fruition. As noted above, even the Federal Reserve expects inflation to remain tame in 2018. Nonetheless, given the tax cut stimulus and potential federal government infrastructure spending, could it be the case that “this time is different” is on a more solid foundation?

Although that would certainly seem to be a prudent base case, it should be noted that this economic expansion is now among the longest in history, and we all know that most economists often don’t see the economic weakness coming until it has already arrived. To expand on that notion, forecasts of higher GDP growth and inflation do not always make actual GDP and inflation rise.

Furthermore, history has taught us that GDP growth and inflation do not always go hand in hand. We have certainly seen times of economic growth coupled with low inflation (recent years) and weak economic growth coupled with higher inflation (think the 70’s). Given these considerations, what does it all mean for interest rates in 2018?

Interest Rates

Given the recent Federal Reserve communications and interest rate market expectations, the 2018 path for shorter-term interest rates would seem to have a fairly high degree of certainty at this time. The federal funds rate is expected to increase three times in 2018, with some now arguing that we could potentially see even four increases. Three increases would take the federal funds target rate in 2018 from 1.50 percent to 2.25 percent by the end of 2018. But what about longer-term interest rates?

During the first two months of 2018 the U.S. Treasury 10-year note finally saw a break above its range of the past several years, albeit by only around 30 basis points at the time of this writing. As such, many have argued that the lows in longer-term U.S. Treasury bond rates are now in the books and we are clearly on our way to higher longer-term interest rates following several decades of falling longer-term interest rates.

However, what about the Federal Reserve Bank’s expectations for a continuation of muted inflation in 2018? Shouldn’t we see inflation pick-up in order for longer-term interest rates to increase?

Unfortunately, in the current environment there are numerous other factors acting on the longer end of the U.S. Treasury yield curve, and the call is not that simple. For example, the Federal Reserve Bank has begun to shrink its balance sheet and thus create more bond supply on the market, causing upward pressures in longer-term interest rates. In addition, federal budget deficits are rising along with the overall federal debt as a percentage of GDP, and conceptually this will increase bond supply and put upward pressure on longer-term yields.

On the other hand, if risk asset markets (e.g. the stock market) were to see sustained outflows at any time in the next several years, this could cause money flows into U.S. Treasury bonds and increase demand. These are just a few examples of the numerous factors at play when assessing longer-term interest rates in the current environment.

The point is that although higher longer-term interest rates may now be a more plausible base case than previous years, numerous winds pushing in both directions will continue to act on longer-term interest rates, and it is not evident at this time which ones will be the prevailing forces. What if the economy does eventually slow down in the latter half of 2018 or into 2019 and inflation remains tame? Could we see longer-term rates fall again?

Again, higher longer-term rates would seem to be the most plausible base case at this time, but there are certain times in history when everybody agreed that one scenario was going to happen, and the actual outcome was the opposite. As such, at Mark H. Smith, Inc. we always advocate looking at both sides of the coin regardless of how sure a bet may seem.