Catalyst News

How to Position Your Balance Sheet for What’s Ahead…Without a Crystal Ball

by Catalyst Corporate | Sep 17, 2019

We’re in the midst of the longest economic expansion in U.S. history, yet the dreaded “R word” has forced its way into the conversation. It has left economists, investors and financial institutions wondering if a recession is truly just around the corner. And if so, how do we prepare?

“With all this uncertainty in the market, it’s a good time for credit unions to evaluate their current balance sheet and to ensure it is positioned it for the cycle ahead,” said Mark Wert, Catalyst Strategic Solutions Senior Advisor.

Wert discussed how to do just that at Catalyst Strategic Solutions’ recent Financial Strategy Symposium in Dana Point, California. Step by step, he walked attendees through the entire process, starting with a thorough assessment of the current economic cycle.

Although it may seem a daunting task, “treat it as a research project,” he said. “Build a research foundation, become a subject matter expert and use your new knowledge to hedge the balance sheet.”

“To properly position your balance sheet for the next economic phase, it’s important to have a strong understanding of the economic cycle as a whole,” he said.

To simplify, Wert broke the process down into five steps:

1. Understanding the economic cycle

To help establish a strong foundational knowledge, he starts with an overview of the business cycle and its four phases: recovery/expansion, peak, contraction and trough. Although they don’t always occur at regular intervals, each phase contains recognizable indicators.   

For example, during the peak phase, the yield curve flattens and then typically inverts. Employment is close to full, policy is more restrictive, interest rates are higher, the stock market eventually tops out and property prices rise. 

It’s this understanding that paves the way to answering the question behind step two: where are we in the current economic cycle?

2. Identifying current economic positioning

Wert summarized the present state of the economy with the following key takeaways:

  • This is the longest expansion in U.S. history, but not the strongest in the post-war era.
  • The credit cycle is leading the economic cycle.
  • The risk of an economic slowdown is on the rise.
  • Globally, there are trillions of bonds with negative interest rates.

This expansion has been years in the making, so the next step is to utilize data to uncover historical trends and other economic factors that may have helped shape the current cycle.

3. Examining data and economic factors

“To better understand how we got here, we must take a closer look at some the most influential economic drivers,” said Wert. Several factors have impacted today’s economy, including: 

  • Jobs – very low unemployment rates are often a precursor for potential recessions, as they can often signal a peak
  • Prices – inflation data & average hourly earnings remain well-contained as inflation remains stubbornly low
  • Housing market – the market remains in good shape but isn’t a huge component of GDP growth
  • U.S. auto sales – remains healthy and is also a smaller component of GDP growth
  • Consumer confidence, employment & personal consumption – all of these are intertwined and show how resilient and healthy the consumer is; consumer spending drives approximately 70% of economic growth
  • Personal consumption versus quarterly GDP – a strong consumer equals solid economic growth

4. Analyzing interest rates (and the story they tell)

“Interest rates and the corresponding yield curve shape is fairly well correlated with the economic cycle,” said Wert. He adds that during the contraction stage, rates fall until they reach a trough, which helps push the economy  into a recession. On the flip side,  in an expansionary stage, rates generally increase until they hit a peak due to Fed tightening as part of its monetary policy.

5. Positioning your balance sheet

Lastly, Wert says to apply this new-found knowledge to formulate an educated guess and anticipate where rates may go next. “Based on this educated guess, you can add or shed interest earning assets or liabilities. Better yet, you just may find that your credit union’s balance sheet is already well-positioned for the anticipated interest rate move,” he concluded.

Ready to take your balance sheet management strategy to the next level? Catalyst Strategic Solutions can help! Our team of advisors offers a wealth of experience and expertise. Find out how they can help you prepare for the next economic cycle and more.