It’s easy to assume that lower interest rates are a panacea. Almost everyone, after all, is affected to some degree by the cost of borrowing. When the Federal Reserve cuts its benchmark rates — as it is expected to do this week for the first time since the pandemic — that makes credit less expensive for consumers and corporations alike.The cheaper debt means companies can spend more to expand, just as consumers might be able to afford bigger homes with lower mortgage rates.
But there is a complicated and somewhat unpredictable interplay between interest rates and the business world. Lower rates bolster the economy, but for companies and their investors, lower rates do not always carry unalloyed positive effects.
Here’s what to expect for corporate America when the Fed lowers rates:
For markets, it’s all about ‘why.’
All else equal, lower rates are good for the stock market. When investors gauge the value of a stock, they tend to come up with a higher figure when interest rates fall because of a common valuation principle known as discounting, in which a company’s future cash flows and costs become more attractive under low-rate conditions.
Fed officials are expected to cut rates by a quarter or a half a percentage point at this week’s meeting. In practice, according to analysts, the reason rates are being lowered matters more than the precise timing or magnitude.
If the economy is faltering, forcing the Fed to lower rates quickly, that can be a headwind to the stock market. A gentle return to a more normal level of rates — at least in the context of the past few decades — is less likely to crimp corporate profits in the way that an economic downturn could.
“It’s less about when they cut and how quickly, and more about why they cut,” said Greg Boutle, head of U.S. equity and derivatives strategy at BNP Paribas.
Some history: The Fed began lowering rates in September 2007, in the early stages of a financial crisis. Over the next 12 months, the S&P 500 fell more than 20 percent. But cuts to rates in 1995 and 1998 came alongside a strong rally for stocks.
For the time being, the consensus among economists appears to be that the economy will remain resilient, underpinning lofty stock valuations. But there is plenty of uncertainty over global growth, geopolitics and the coming presidential election weighing on investors.
Bank on mixed news for lenders.
There are few businesses more sensitive to interest rates than banks. That’s because lenders generally make money off the difference between what they pay depositors and what they charge to borrowers, such as home buyers in need of mortgages and trading firms who want leverage to supercharge their bets.
That difference is known as a spread, and higher rates allow banks to collect a larger spread. No wonder, then, that the biggest bank stocks dropped last week when executives from major institutions such as JPMorgan Chase warned that analysts were being too optimistic about how lenders would fare if rates drop and spreads shrink.
On the flip side, large investment banks like Goldman Sachs and Morgan Stanley as well as some corporate law firms have been hankering for the fees they can collect for advising on mergers and acquisitions, when one company buys another. Lower rates make it cheaper for those companies — or the private equity firms that back them — to take out loans to support those purchases and increase the likelihood of deals coming together.
Remember, though, that while mergers can pay off for investors and corporate executives whose contracts include deal-based payouts, rank-and-file employees could see their jobs disappear as part of “synergies” or cost-cutting efforts needed to pay back the loans that made the deals possible.
Commercial landlords will take all the help they can get.
While the Fed’s benchmark rate does not directly affect residential or commercial real estate mortgage rates — it can take months for lower interest rates to trickle down — landlords rely heavily on debt and will welcome any relief in the form of refinancing.
It will take far more than a drop in rates, however, to save the flailing office market. Many of the most distressed (i.e., empty) commercial buildings are in relatively unpopular downtown areas, and as many employees continue working remotely, it’s unclear if these spaces will ever be financially viable again.
And if lower rates allow more commercial properties to change hands at lower prices, that could force big landlords to lower the value of comparable properties in their portfolios. Many landlords and investors have been resisting this, arguing that the lack of recent comparable transactions makes the exercise futile.
An uptick in activity spurred by lower rates could prompt a cascade of falling building valuations.
Cue a business borrowing binge.
If companies can borrow more cheaply, the savings should mean they can spend more on hiring, for acquisitions, or to reward their shareholders with stock buybacks and dividends. That spending is one way lower rates would flow through the global economy.
But if lower rates are accompanied by rising macroeconomic worries, lenders could be hesitant about extending credit to indebted, struggling companies. In that case, the interest rates on offer might not change all that much.
For now, those worries remain on the back burner, and the prospect of lower rates has already revitalized appetite for lending from bond investors trying to lock in higher rates — and higher returns — before the Fed begins to cut. That has been welcomed by corporate America, especially by companies whose bonds are due in the near future or borrowers with weaker credit ratings.
Riskier, “high-yield” bond sales are coming in at a faster clip than they have in the past couple of years, with nearly $200 billion of borrowing in 2024 so far, according to the data provider Refinitiv. Pitchbook, another data provider, also noted a flurry of borrowing in August and September across bond and loan markets.
Everyone tries to predict the economy, but no one can.
Let’s be clear: The fact that the Fed is likely to cut interest rates is good news overall, in that it is the clearest sign yet that inflation is coming under control.
Price increases have been slowing for years. Overall Consumer Price Index inflation stood at 2.5 percent in the year through August, down from a peak of 9.1 percent in the summer of 2022.
As inflation approaches a normal pace, it has allowed the Fed to focus more intently on its other goal: maintaining a strong job market. By lowering interest rates gradually, the Fed is hoping to cool inflation without grinding the job market to a halt.
So far, consumer spending is holding up and hiring is continuing, albeit at a slower pace than in 2022 and 2023. But the unemployment rate has been creeping up over the past year, a warning that the Fed could overdo its efforts to cool the economy.
Christopher Waller, a Fed governor, acknowledged in a recent speech that figuring out the perfect speed to cut interest rates in order to nail the so-called soft landing could be a challenge.
A slower pace of cuts would come at “the risk of moving too slowly and putting the labor market at risk,” he said. But, he added, “cutting the policy rate at a faster pace means a greater likelihood of achieving a soft landing but at the risk of overshooting on rate cuts.”
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