Why Federal interest rates matter to railroads (but later next year)

Phew. We're all still here, thank goodness.

With the hype and speculation leading up to the Federal Reserve's interest rate rise today, I thought the world might come to end, or worse, the stock market might go down. For the record, the Fed raised interest rates from near ZERO to between 0.25 and 0.5 percent, representing the interest other banks pay the Federal bank, not what you pay on a new loan. It is the first rate raise since before the Great Recession.

"So what does this mean for railroads?!" you say.

Glad you asked.

In the short term, little or nothing. Railroads, like any other big business, borrow money from time to time because it is more convenient than keeping a big savings account ready to go to pay for locomotives, payroll, or track projects. The extra amount railroads will have to pay to a bank in interest will still be small and for a long time to come.

No, any affects increasing interest rates have will be down the road on traffic, maybe in six or nine months and after one or two more interest rate rises from the Federal Reserve.

Why? Because we as consumers will all be paying more on our end for the goods that railroads haul, and all else being equal, consumers buy less when prices rise.

Here's an example: Today's "zero-money down, five-years same as cash" financing for a new car will likely go away in favor of a deal that requires $1,000 or more in a downpayment or a minimal interest rate — maybe both. The price for the car might be the same, but the financing suddenly costs you something. If that happens, are you and your friends as likely to buy a new car as when you only had a no-interest monthly payment? If not, then the car dealership will sell fewer cars; General Motors, Volkswagen, and Toyota will have fewer cars to send in autorack unit trains; and suppliers will send fewer parts and demand less steel in gondolas. You get the idea.

Or what about a house? Ever pay points on a mortgage to get the annual interest rate down? I did it a couple of times and those points will cost more money, and the average annual rate will get higher too. Higher interest rates on mortgages means fewer people will be able to afford to buy a new house. Houses, you may know, take up a lot of lumber, asphalt, aggregates, copper, steel pipe, and countless other materials that railroads haul. Current homeowners are also less likely to make big improvements that take the same kinds of goods with higher interest rates (because homeowners put a lot of home improvements on their credit cards.)

And on it goes down the line from washing machines and microwaves, to farm equipment, and road paving materials.

The good news is that because the Federal Reserve raised interest rates, the Federal Reserve governors believe that U.S. businesses and consumers (hey, you and me) have money to burn and will "soon" start buying enough goods to make up for the differences we'll see in financing and maybe, just maybe, raise inflation. The trouble, of course, is that the Fed could be wrong and that we're all not all so well off and an interest rate rise will cut what we buy and what the railroads haul.

Let's check back in six months and see what happens.