The series of interest rate hikes that took place throughout 2023 had a marked impact on the financial performance of organizations in the government, higher education, and non-profit sectors. The rapid rise in rates has required organizations to evaluate new and different approaches to effectively manage their assets and liabilities.

“A lot of organizations are still adjusting to how higher rates impact their finances. They’re essentially having to reset from the conditions of the past 15 years, when interest rates were low and there was a lot of available stimulus and liquidity,” said Rob Dailey, head of PNC Public Finance. “Now, they need to rethink how to optimize their assets, given the opportunity the higher rates present for investing operating cash and strategic reserves, and they also have to consider the implications of what type of debt they take on, whether bank debt or municipal securities debt. It’s a new environment that organizations will have to continue to adapt to throughout 2024. This additional dynamic adds to the challenge our clients face in day-to-day operations, as they look to improve efficiency, streamline costs, avoid cyber fraud, and catch up to advances in banking operations and treasury management.”

Bond Market Conditions and Implications for Issuers

In the bond market, the interest rate backdrop has created new opportunities. There are different issuance products in play now, beyond simple long-term fixed-rate bonds, and organizations may find significant value in tailoring their debt portfolios based on the broader range of debt products. Issuing and managing debt will require taking a close look at the broader set of variables in the environment. 

For issuers of municipal securities, the ongoing volatility continues to drive challenges. With rates moving in large increments quickly, issuers need to plan issuances thoroughly and carefully, focusing on the quality of execution and communicating clearly with the market and with investors. Issuers may also face constraints on projects and funding, stemming from inflation and federal restrictions on how the funds may be used. 

Rate Implications for Borrowers

The prolonged inverted yield curve, in which longer-term bonds have a lower yield than short-term debt instruments, has led some institutions, including PNC, to predict a mild economic recession in mid-2024. However, if the yield curve begins to show signs of normalizing in the latter half of the year, this may lead to an uptick in both municipal securities and bank activity, as organizations reevaluate which debt products and structures best meet business needs. In the meantime, financing at short-term rather than long-term rates may present a more appealing option for public, non-profit, and higher education organizations. 

Implications for Government Entities

Among government entities, there are concerns about an impending “fiscal cliff,” as governments continue to spend COVID-19 relief and other stimulus dollars issued by the federal government. As a large portion of the overall stimulus funds currently remains unspent, many state and city governments have become accustomed to having the federal funds as part of their operating budget. When the funds eventually roll off these entities’ balance sheets, they will be forced to adjust to the drop in revenue through raising taxes, cutting expenses, or making other challenging policy decisions.

Spending on infrastructure projects, such as building or improving roads, bridges, and water systems, is likely to ramp up over the next five years, as governments look to spend allocated federal funding. Federal infrastructure spending will likely spur complementary projects driven by state and local governments. This may lead to an increase in demand for project debt, as surpluses within state budgets are depleted.

Volatility Sets the Tone

The financial stability of governments, higher education institutions, and non-profit organizations may be particularly vulnerable to the impact of interest rate changes and other macroeconomic factors. But it’s important to remember that there are ways to adapt to the current economic cycle, according to Dailey. “There is a lot of uncertainty right now, but eventually things will stabilize,” Dailey said. “In the meantime, it’s important for organizations to pay close attention to all of the variables in play and develop strategies to stay nimble.” 

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