What happens to the world’s largest economy when corporations finally start to feel the heat from higher rates?

That’s a question market participants will eventually have to grapple with assuming, of course, any recession that materializes between now and whenever corporates are compelled to refinance doesn’t end up driving rates back down to rock-bottom levels.

As discussed here+ on Tuesday afternoon, the borrowing bonanza witnessed across 2020 and 2021 helped push the notional share of IG and junk bonds maturing within two years to the lowest since at least 2007. Put differently, trillions in debt issuance underwritten by the post-pandemic, pre-inflation Fed “put,” lengthened the duration of corporate debt, thereby further desensitizing the economy to rate hikes.

That’s one, among many, reasons the US hasn’t succumbed to recession. Corporates simply haven’t been impacted by Fed tightening in a direct way, and where they have, it’s been a boon — banks enjoyed a huge NII boost, and non-financial firms were able to earn ever higher rates on enormous cash balances.

But all good things must come to an end. As debt starts to mature, corporates will need to lean on cash to fund spending (which they’re already doing) or else face the music, where that means rising interest expense from new debt incurred at higher rates. This is shareholder capitalism, which means the C-suite isn’t simply going to eat the higher cost of debt — doing that would crimp margins, to the chagrin of equity owners, the only stakeholders who’ve mattered in the US since the late 1980s.

Instead, corporates without cash buffers will cut capex, jobs and wages in the face of higher interest costs. The larger those cuts, the more pronounced the economic drag. Based on an analysis of firms’ reaction to higher interest expense going back to 1965, Goldman estimates that combined drag at 0.05pp on annual GDP growth next year and 0.10pp in 2025.

That doesn’t sound like much, and indeed Goldman described it as “modest,” but consider that the Fed is trying to engineer below-trend growth, and also that lower capex and job cuts don’t just happen in a vacuum. When orders get canceled, that impacts the outlook for employment in other sectors, for example, and job losses have all manner of ripple effects. If growth is only, say, 0.9%, a 0.10pp drag due solely to the knock-on effect of corporates refinancing maturing debt at higher rates is a lot.

But the more interesting bit from Goldman was the bank’s assessment of how “the hit to activity from higher interest expense could be either smaller or larger than usual.” The bank’s Ronnie Walker and Sienna Mori noted that cash balances are still very high.

“Firms could use that cash to either reduce their debt load instead of refinancing or to smooth their capital expenditures and labor costs,” Walker and Mori wrote.

Of course, not every firm is cash-rich. According to SocGen’s Andrew Lapthorne, the top 10% of companies by market cap control around 70% of corporate cash balances.

And then there’s the growing number of loss-making enterprises. “The number of unprofitable firms has continued to proliferate,” Goldman remarked.

The figure on the left, above, from Walker and Mori, shows that nearly half of all publicly-listed companies were unprofitable last year. In the right pane, you can see that the share of such firms forced to unceremoniously exit has fallen.

“Unlike in typical recessions, the exit rate has declined since the start of the pandemic,” Goldman went on, attributing that phenomenon in part to “generous fiscal support that is no longer being provided.”

The implication: In the absence of that fiscal support, unprofitable firms will, at the least, struggle in the face of higher expenses, including those associated with debt.

Not surprisingly, Goldman found that unprofitable firms “disproportionately cut back on employment and capex when faced with margin pressure.”