The following is an article written by Trellance’s Vice President of Lending & Regulatory Analytics, Dan Price. It originally appeared on CUInsight.com.
As interest rates and inflation begin to level out, discussions have begun to turn towards the future of the economy. Some speculate that risk of a deflationary period may be just around the corner, leading to a lower rate environment headed our way. We’ll inevitably see a shift in the current economic environment, and credit unions must be prepared to meet the next challenge.
What Is Deflation?
Deflation is, simply, the opposite of inflation. Inflation occurs where there isn’t enough supply to meet the demand; conversely, deflation happens when there is more supply than there is demand. In an inflationary period, manufacturers, who are seeing a boost in revenue, will start increasing production in order to meet the level of demand. The opposite, of course, is true for a deflationary period. Manufacturers will reduce production, and perhaps even staff, in order to avoid a surplus inventory and to save on costs.
During the pandemic, a combination of supply chain issues and increased spending resulted in the inflated environment we’ve seen grow over the last few years. As a result, the Federal Open Market Committee began raising interest rates in an attempt to cool off the market. Currently, we sit at a rate of 5.25%-5.5%.
Thanks to inflation and raised interest rates, spending has indeed decreased, leading to lowered demand for products, services and travel. This does not necessarily mean we are headed to a deflationary market, however. While demand is certainly lower and we’re seeing the results of over-hiring during the pandemic now, in layoffs across the tech sector, it is unlikely we will enter a true deflationary period.
Deflationary periods have been very rare across our history. The most recent occurrence of deflation was in 2015, at a rate of 0.1% – practically nothing – and in 2009 before that. Other than those two instances, the US has not had a deflationary period for the last 60 years.
What Sort of Market Should Credit Unions Expect?
While a true deflationary period is not likely, we must remember that what goes up must (generally) come down. In this case, credit unions should expect that interest rates will inevitably begin to lower as the market continues to cool. It may not be right away – it can be a bit hard to tell, with the Fed – but it will happen eventually, and the best thing credit unions can do is be prepared for that eventuality.
During the pandemic, interest rates hit record lows, and consumers were quick to take advantage. Those that missed out, however, still found themselves in need of cars, houses, credit cards, and other large ticket purchases in the following years, when interest rates reached new heights. As interest rates begin to lower, those home and vehicle owners who found themselves with upwards of 7% interest rates will start to look at refinancing options. Credit unions must make sure they are in a position to capture, or even retain, that refinance activity.
So no, a deflationary period is not likely to affect us in the US anytime soon – but a lower rate environment probably will. So make sure your credit union is prepared to address the realities of a lower rate environment, and that you’re prepared to capture any refinance activity.
Dan Price is the Vice President of Lending & Regulatory Analytics at Trellance.
