The future is hard to predict, but when it comes to interestrates, credit union experts like Brian Hague are increasinglyconfident about what's going to happen.

“They're going higher,” Hague, a senior consultant at TheRochdale Group Inc., a credit union consulting firm in OverlandPark, Kan., said.

That prospect has a lot of implications for credit unioninvestments. Part of formulating an effective investment policymeans projecting the timing of the Fed's rate changes. But that'sespecially tricky right now, CUNA Senior Economist Mike Schenksaid. For example, as shown in the image above, the yielddifference between the 10-year Treasury and the 10-year TIPS is animplicit forecast of inflation out 10 years.

“There are a lot of things that appear to be red flags and causequite a bit of concern going forward,” he explained.

Though the Fed's own data points to a ratehike this summer, Schenk said there's also a good chancenothing will happen in 2015 in part, because of the effects ofdeflation in the Eurozone and Greece's precarious situation. Slackin the domestic labor market and declining GDP growth in China alsoweaken the case to raise rates, he noted.

“There's a lot of people that are arguing that the Fed haspainted themselves into a corner,” Andrew McGeorge, CFO of the $2.5billion Service Credit Union in Portsmouth, N.H., said. “Even ifthe data [doesn't] support it, they might have to make a token rateincrease this year, just because they'll lose their credibility ifthey don't.”

McGeorge added, “If rates go up, it's likely that rates are likely to go up by alarger amount at the short end of the yield curve, especiallyovernights, two-year, three-year-type things,” Those are the typesof investments that will get more play. It will be more enticing tokeep money in cash.”

He continued, “A lot of credit unions have completely given upon two-year bullet or two-year callable investments because theyields are so dismal. They're just buying five-year bonds or buyingmortgage-backed securities, so it's those types of areas that willlikely see the greatest lift.”

Bill Conerly, an economist and business consultant with ConerlyConsulting LLC in Lake Oswego, Ore., said duration is a populartopic these days.

“The big thing that people are talking about is should they golonger term or should they stay on the short end of the curve andinvest for three months or six months.”

Conerly said he thinks June might be go-time for a Fed ratehike.

“There's not been a lot of interest in long maturities in thelast few years, because of this belief that rates are going up andbetter to keep your powder dry and be ready to invest more at thehigher rates,” he noted. “But that has not proved to be a winningstrategy.”

Once there is a rising rate environment, credit union treasurerswill feel much more confident at extending out the yield curve andgoing for longer-term notes and bonds, Conerly said.

“I've seen some credit unions that have shortened up inanticipation of [rising rates], and I've seen some credit unionsthat aren't doing anything about it yet,” Hague said. “At the onesthat I've seen, I haven't seen really extreme long duration plays.Those folks should probably move sooner rather than later torestructure, because you know if they wait until rates go up,obviously, they've got to take losses when they sell.”

McGeorge said he's seen more evidence of credit union investmentactivity in things such as SBA-backed loan pools.

“They offer very good yields,” he said. “They do come with somerisks. They're floating-rate instruments with caps, so if you thinkrates are going to go up a lot, you're not necessarily going toparticipate in all the upside. I think the liquidity of them isvery tenuous. If you get a big portfolio of them and you needed tounload it, you're probably not going to be able to get fair valuefor them.”

Expected double-digit increases in loan demand in 2015 may have credit unions looking for cash tolend, but in a rising-rate environment, that won't necessarily comefrom deposits.

“We think there's a lot of money parked in what aretraditionally viewed as core deposits that aren't core deposits,”Schenk explained. “It's essentially hot money, and it's sittingthere waiting for money market interest rates to go up.”

Money market mutual funds will not lag that increase in cost, sothe yields there will go up very, very quickly, and we'll start tosee disintermediation, he continued.

“It's going to be a combination on both sides of the balancesheet, probably not declines in savings balances, but very slowgrowth in savings balances combined with more loan growth, andthat's going to say to most credit union investors, 'Gosh, I betterhave most of my investments in portfolios that can be quicklyconverted to cash to meet some of these outfalls,'” Schenksaid.

The real motivator for change in credit union investments is notso much that rates will be going up a little bit in the nearfuture, he pointed out. It's that loans will continue to grow, andliquidity will become plentiful.

“With tight liquidity, you're going to want to stay short andliquid, and I think, probably obviously, a rising rate environmentstrengthens that initiative.”

Hague said, “You've got deposits that re-price frequently, andyou've got longer-term fixed-rate assets that those deposits arefunding and they don't re-price as frequently, and as rates rise,they're even less likely to re-price, because mortgages aren'tgoing to refinance when rates are going up. Obviously, your cost offunds, then, is rising and the earning rate on those assets isnot.”

With lower down payment requirements on Fannie Mae and FreddieMac mortgages, lower FHA mortgage insurance premiums and pent-updemand, 2015 should be solid for housing, Hague said.

“But I would recommend that they sell those loans, becauseagain, we're looking at record low rates. Those loans aren't goingto prepay very quickly. So they're going to want to get thoselow-earning assets off their books,” he said.

On Jan. 15, the NCUA Board issued a second proposed rule onrisk-based capital for credit unions that amended a proposal issuedabout a year ago.

“I think the NCUA's ultimate approach to interest rate risk willbe the regulatory driver of how credit unions behave from aninvestment perspective,” Schenk said.

While the original proposal gave too much weight to interestrate risk and penalized credit unions with longer-term investmentsand other assets, according to Schenk, the subsequent versionoffered a breather.

“We've got a longer period of time to adjust to this,” he said.“We're going to see rising interest rates in the short term, andthen, four years down the road, have to wrestle with risk-basedcapital.”

Risk-based capital isn't the only regulatory focus. “The onlyreal change that there's been in the credit union investmentregulatory landscape recently has been, and it's not that recentnow, has been the expansion of hedging authority,” Hague said. “That's another avenue forcredit unions, that they can use derivatives to hedge theirinterest rate risk. That can be a very effective and cost-effectiveway to manage interest rate risk if you know what you'redoing.”

Still, that strategy is pretty limited, Hague cautioned.“Ittends to be the larger and more sophisticated players, or some thatare using investment advisers that have some knowledge about thosestrategies. But even then, I haven't talked to a credit unionsmaller than a couple billion in assets, at least, that's doing it.Even those are using advisers.”