Higher-for-longer interest rates favor large companies over their smaller rivals in many ways

Higher-for-longer interest rates favor large companies over their smaller rivals in many ways

Feb 18,2024

A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.

Washington, DC CNN  — 

The days of ultra-low interest rates are long gone, and the Federal Reserve could begin paring back its key interest rate from a 23-year high later and less aggressively this year than markets expect. High interest rates squeeze companies of all sizes, but that’s especially the case for smaller firms, unlike large companies better equipped to weather the storm.

It’s a vastly different reality from when rates were near zero in the early days of the Covid-19 pandemic, when the Fed cut aggressively to stimulate a battered economy dealing with high unemployment and a sudden pullback in spending. Before the pandemic, the Fed’s key interest rate, which influences borrowing costs across the economy, had not gone above 3.25% since 2009. It’s currently at a range of 5.25-5.5%.

That was an era of “easy money,” since it wasn’t so costly for consumers and businesses to access credit. Since inflation has slowed markedly from its four-decade peak in the summer of 2022 without the economy deteriorating, at least for now, the Fed doesn’t have any incentive to cut rates as soon as March or to bring them near zero.

The Fed is responsible for stabilizing prices and maximizing employment, and it reduces interest rates when unemployment is rising or when the rate of price increases slips below the central bank’s 2% goal.

Before the Bell spoke with Lauren Goodwin, economist and chief market strategist at New York Life Investments, to discuss the implications of higher-for-longer rates.

This interview has been edited for length and clarity.

Before the Bell: How do the effects of higher-for-longer interest rates on companies vary by size?

Lauren Goodwin: More challenging economic environments tend to favor larger companies on most levels. They tend to have more buffer, a larger capital stock and bigger reserves. In some industries, like banking, they would be more heavily regulated so there are more protections in place, so they tend to navigate storms better. It’s part of why we are seeing investors beginning to flock to large caps in this sort of late stage in the economic cycle. By contrast, small companies tend to perform best when economic growth is accelerating because there’s more of a risk-on environment writ large and tend to struggle when investors are more uncertain.

What would higher-for-longer rates mean for mergers and acquisitions?

I think the premise that there might be opportunities for larger companies to acquire smaller companies stands to reason, but the only thing that I would add is that a higher rate environment, especially if economic growth or top-line revenue is slowing, is challenging for everybody, including the capital markets. There’s lots of different ways that mergers and acquisitions can be done, but we know that M&A activity has been slower in the last year as a result of the high interest-rate environment. I think it might be a stretch to say that M&A activity picks up because of higher interest rates, so instead, it’s that if good businesses are beginning to suffer because of higher interest rates, then they might be more likely to be a target.

What’s the outlook for M&A activity given that the Fed might not cut rates as aggressively?

The market is pricing in three interest-rate cuts this year of 25 basis points each. That’s about what the Fed has told us for the last several quarters. Cutting interest rates by 75 basis points over the course of this year is still restrictive policy, so it will still be a similar environment for mergers and acquisitions specifically. There’s a reasonable likelihood that the Fed ends up cutting quite a bit more this year — if economic activity slows more than expected. That’s where that dichotomy in the mergers-and-acquisitions environment plays out because while interest rates would be moving lower, potentially freeing up some capital or creating a cheaper source of capital for companies that wanted to engage in a merger or an acquisition, economic growth is already slowing at that time. If that’s the case, there’s likely lower revenue for many companies as a result.

Don’t look now but gas prices are rising fast

You’re not imagining it: Gasoline prices are moving swiftly higher across the country, my colleague Matt Egan reports.

The national average has climbed 11 cents in the past week alone, to $3.28 a gallon, according to AAA. That means millions of Americans hitting the roads this Presidents’ Day weekend will be greeted by the highest prices in nearly three months.

Some of this jump in pump prices is normal. Gas prices always rise as winter winds down because demand increases and gas stations must switch over to more expensive summer fuel.

Some of this jump is abnormal. Refinery outages — including a weekslong shutdown of the largest refinery in the Midwest — are limiting the supply of gas.

No matter the cause, rising gas prices are bad news for consumers already frustrated by the cost of living.

And this trend could cause headaches for officials in Washington — especially if it accelerates. Higher gas prices complicate the Federal Reserve’s war on inflation. And they undercut the election year message of a White House that previously pointed to cheap gas prices as evidence that Bidenomics is working.

The higher prices go, the bigger the headaches.

“It’s a very sensitive subject for Americans,” said Patrick De Haan, head of petroleum analysis at GasBuddy. “The White House is somewhat powerless. The president doesn’t really deserve credit or blame. The market will do what it’s going to do.”

Read more here.

Up Next

Monday: US markets are closed in observance of Presidents’ Day.

Tuesday: Earnings from HSBC, Walmart, Home Depot, Barclays, Caesars Entertainment and Dillard’s.

Wednesday: Earnings from Nvidia, Rivian, Fidelity, Marathon, Etsy, Wingstop and Marriott. The Federal Reserve releases minutes from its policymaking meeting in January. Fed officials Raphael Bostic and Michelle Bowman deliver remarks.

Thursday: Earnings from Intuit, Pacific Gas & Electric, Live Nation and Wayfair. S&P Global releases February business surveys gauging economic activity in the United States. The Chicago Fed releases its National Activity Index for January. The US Labor Department reports the number of new applications for jobless benefits in the week ended February 17. The National Association of Realtors reports the number of existing-home sales in January. Fed officials Philip Jefferson, Patrick Harker, Lisa Cook, Neel Kashkari and Christopher Waller deliver remarks.

Friday: Earnings from Warner Bros. Discovery and Icahn Enterprises.

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