How long before the most aggressive rate-hiking campaign in a generation finally bites corporates?
It’s an ad nauseam question. In some sense, it’s rhetorical. We know the answer because we’ve all seen the charts.
A snapshot of funding mix (fixed versus floating) and maturity walls (termed-out versus steep) makes it obvious: The answer is “yesterday” for smaller companies (and particularly for very small, non-public businesses) and “probably never” for the largest of the large, with a caveat to account for the tail risk that “high for longer” ends up meaning “high forever” due to a permanent reset in r-star tied to structural macro shifts.
There’s a lot to unpack there. Even if “soft landing” is now the macro base case in the US, even if there isn’t a double-dip profit recession and notwithstanding the fact that the most “important” companies (for cap-weighted benchmark stock indexes, anyway) are relatively insulated, you have to believe the bill for the Fed’s hiking cycle will be paid eventually, one way or another, and at least in aggregate, that’ll mean higher interest costs.
Consider the figure above, from SocGen, whose Albert Edwards has revisited this topic on multiple occasions over the past 12 or so months.
As noted, the red line (interest costs as a share of gross value added) is lagged by five quarters. The implication is clear, and just in case it isn’t, the chart header is unequivocal.
“Lower interest cost frees up more cash for corporations and provides them with the flexibility to deal with immediate liquidity needs,” SocGen strategists including Jitesh Kumar and Vincent Cassot remarked, editorializing around the visual. “Going forward, however, the interest cost for corporations should increase, putting more strain on corporate balance sheets.”
Note that with recession odds fading, so too is fund managers’ concern with balance sheet discipline.
From December to January, the net share of panelists in BofA’s Global Fund Manager Survey who said a recession is likely in the next 12 months dropped from 15% to just 2%.
“These improving expectations for the economy have coincided with less focus on the need for balance sheet improvement by corporates,” BofA’s Michael Hartnett said.
Again, though, it’s all about the corporate “haves” versus the “have-nots.” As the lagged impact of higher real rates works its way through, it’ll be “felt more acutely by the more indebted and cash-poor companies,” as SocGen put it which, for investors, “argues for a preference for strong balance sheets.”
I traded only hedged positions for most of my career. The mythology was that they were true hedges. I was taught any r squared below 95 meant you didn’t have a proven relationship. I never had a risk manager call me out on this. My view is trading is riskier than even experienced participants realize. Gambling is a dirty word that isn’t really dirty. I once had a ceo describe my business as riskless arbitrage. Oh really?
Seems like CRE -> banks is worth paying attention to as well
I wonder whether, like most things post-pandemic, that lagged net interest line will follow the real Fed rate line as quickly or closely as it has typically in the past. Seems like the IPO drought and SPAC meltdowns may have already put a decent dent in the zombies and other marginal borrowers. (The cynic in me notes that no matter what the interest rate, interest costs won’t increase on enterprises that go defunct before the bill comes due). Moreover, with equities pushing to new highs, M&A and IPOs may relieve some debt squeezes.
But the only bet I’d lay is that corporate America as a whole, flush with inflation-aided record profit margins, will not hesitate to use higher interest rates (if not costs) as a rationale to further raise prices.