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After cutting short-term interest rates 13 times, the Federal Reserve did something on the last day of June that it hadn’t done in nearly four years. In a move that had been expected for months, the Fed raised the Federal Funds rate a quarter point to 1.25 percent. This is the first of what is likely to be many increases. Over the next year, we should see the Fed Funds rate rise to 2.5-3 percent from its current levels. In anticipation of the Fed move, long-term interest rates have been rising for nearly a year.
Rising interest rates reflect an improving economy. They also reflect the Fed’s fear of rising prices. The question that many retailers and their suppliers are asking is: So what does this really mean to me?

Short- and Long-Term Interest Rates
The credit markets have a stellar record of forecasting the economy, if you know how to read what they are saying. When short-term interest rates rise above long-term rates as they did in 1989 and again in 2000, the credit markets are warning of a recession. When there is a wide variance between short- and long-term rates, as there is now and as there was back in 1993, the credit markets are forecasting a booming economy.
A wide spread between short- and long-term rates means that bank margins are very large and hence, banks have an incentive to lend. Money is what makes the mare run and nothing creates money like bank lending. Since the rate increase in June, long-term interest rates have actually fallen. The increase in short-term rates and the drop in long-term rates narrows that spread and thus, reduces the growth of bank lending and the economy.
For retailers, a slowdown in bank lending will translate into a slightly slower pace of real estate development and perhaps more stringent lending on inventories. On balance, the rise in short-term interest rates will translate into slower growth and less inflation for the economy as a whole in the months ahead.
Rising inflation is generally a mild positive for retail profitability. Rising prices allow most retailers to pad margins and add to inventory profits. At the very least, rising prices add to the top line and take some of the pressure off of the need for more productivity growth as a booster to profitability. With rising interest rates, that top line pressure is going to intensify.
For suppliers, rising interest rates represent an increase in the cost of doing business. As retailers force suppliers to hold a greater proportion of the inventory in the supply chain, the cost of financing this inventory rises with short-term interest rates.
The stock market generally reacts poorly to rising interest rates. Stock prices are discounted cash flow and a rise in interest rates increases the rate of discount and reduces the value of future cash flow, and hence, stock prices. Raising capital in the stock market becomes more difficult.
Some consumer credit card rates are tied to short-term interest rates and the rates they charge on credit balances will rise. Consumers, however, have never shown themselves to be very sensitive to small changes in credit card interest rates, particularly for small-ticket purchases.

Food Stores and Drugstores
The rise in interest rates may be modestly positive for food stores and drugstores. Food stores and drugstores cater to an older clientele who are often on a fixed income. Lower inflation helps these customers as do higher interest rates. With some of their income tied to rates paid on certificates of deposit, these customers will find they have a bit more income, along with a bit more purchasing power.
More recently, food stores and drugstores have consistently experienced a higher rate of inflation than other lines of retail trade. With the Fed trying to crack down on inflation, drugstores may find themselves on the front line of the fight against inflation. A recent AARP study shows drug price inflation to be running nearly three times the general rate of inflation. If monetary policy is not successful at reigning in drug prices, which is not likely, then drugstores are somewhat at risk to increased government regulation of drug prices.

Mass Merchants
The real pinch of higher interest rates on consumers may be found in housing and auto sales. Rising interest rates increase the monthly payment for big-ticket purchases like housing and autos. With a weaker housing market, mass merchants can expect to see slower sales for home-related items. When auto sales slow, however, sales of auto repair and accessory items tend to do better.
As higher interest rates translate into a slower economy, that should give a slight advantage to value-oriented retailers. With wage increases still negligible, wage-dependent consumers will remain very price sensitive. In a mildly inflationary environment, that gives an added edge to those retailers who can hold the line on prices.