Federal Reserve Bank of Chicago

Latest story

138 Shares199 Views

Corporate America Has Dodged the Damage of High Rates. For Now.

by

Small businesses and risky borrowers face rising costs from the Federal Reserve’s moves, but the biggest companies have avoided taking a hit.The prediction was straightforward: A rapid rise in interest rates orchestrated by the Federal Reserve would confine consumer spending and corporate profits, sharply reducing hiring and cooling a red-hot economy.But it hasn’t worked out quite the way forecasters expected. Inflation has eased, but the biggest companies in the country have avoided the damage of higher interest rates. With earnings picking up again, companies continue to hire, giving the economy and the stock market a boost that few predicted when the Fed began raising interest rates nearly two years ago.There are two key reasons that big business has avoided the hammer of higher rates. In the same way that the average rate on existing household mortgages is still only 3.6 percent — reflecting the millions of owners who bought or refinanced homes at the low-cost terms that prevailed until early last year — leaders in corporate America locked in cheap funding in the bond market before rates began to rise.Also, as the Fed pushed rates above 5 percent, from near zero at the start of 2022, chief financial officers at those businesses began to shuffle surplus cash into investments that generated a higher level of interest income.The combination meant that net interest payments — the money owed on debt, less the income from interest-bearing investments — for American companies plunged to $136.8 billion by the end of September. It was a low not seen since the 1980s, data from the Bureau of Economic Analysis showed.That could soon change.While many small businesses and some risky corporate borrowers have already seen interest costs rise, the biggest companies will face a sharp rise in borrowing costs in the years ahead if interest rates don’t start to decline. That’s because a wave of debt is coming due in the corporate bond and loan markets over the next two years, and firms are likely to have to refinance that borrowing at higher rates.Overall Corporate Debt Interest Payments Have PlummetedAlthough the Fed has rapidly raised interest rates, net interest payments paid by corporations are reaching 40-year lows.

Note: Data consists of interest paid by private enterprises (minus interest income received) as well as rents and royalties paid by private enterprises.Source: Bureau of Economic AnalysisBy The New York TimesThe junk bond market faces a ‘refinancing wall.’Roughly a third of the $1.3 trillion of debt issued by companies in the so-called junk bond market, where the riskiest borrowers finance their operations, comes due in the next three years, according to research from Bank of America.The average “coupon,” or interest rate, on bonds sold by these borrowers is around 6 percent. But it would cost companies closer to 9 percent to borrow today, according to an index run by ICE Data Services.Credit analysts and investors acknowledge that they are uncertain whether the eventual damage will be containable or enough to exacerbate a downturn in the economy. The severity of the impact will largely depend on how long interest rates remain elevated.“I think the question that people who are really worrying about it are asking is: Will this be the straw that breaks the camel’s back?” said Jim Caron, a portfolio manager at Morgan Stanley. “Does this create the collapse?”The good news is that debts coming due by the end of 2024 in the junk bond market constitute only about 8 percent of the outstanding market, according to data compiled by Bloomberg. In essence, less than one-tenth of the collective debt pile needs to be refinanced imminently. But borrowers might feel higher borrowing costs sooner than that: Junk-rated companies typically try to refinance early so they aren’t reliant on investors for financing at the last minute. Either way, the longer rates remain elevated, the more companies will have to absorb higher interest costs.Among the firms most exposed to higher rates are “zombies” — those already unable to generate enough earnings to cover their interest payments. These companies were able to limp along when rates were low, but higher rates could push them into insolvency.Even if the challenge is managed, it can have tangible effects on growth and employment, said Atsi Sheth, managing director of credit strategy at Moody’s.“If we say that the cost of their borrowing to do those things is now a little bit higher than it was two years ago,” Ms. Sheth said, more corporate leaders could decide: “Maybe I’ll hire less people. Maybe I won’t set up that factory. Maybe I’ll cut production by 10 percent. I might close down a factory. I might fire people.”Small businesses have a different set of problems.Some of this potential effect is already evident elsewhere, among the vast majority of companies that do not fund themselves through the machinations of selling bonds or loans to investors in corporate credit markets. These companies — the small, private enterprises that are responsible for roughly half the private-sector employment in the country — are already having to pay much more for debt.They fund their operations using cash from sales, business credit cards and private loans — all of which are generally more expensive options for financing payrolls and operations. Small and medium-size companies with good credit ratings were paying 4 percent for a line of credit from their bankers a couple of years ago, according to the National Federation of Independent Business, a trade group. Now, they’re paying 10 percent interest on short-term loans.Hiring within these firms has slowed, and their credit card balances are higher than they were before the pandemic, even as spending has slowed.“This suggests to us that more small businesses are not paying the full balance and are using credit cards as a source of financing,” analysts at Bank of America said, adding that it points to “financial stress for certain firms,” though it is not yet a widespread problem.Corporate buyouts are also being tested.Carvana renegotiated its debt this year to defer mounting interest costs.Caroline Brehman/EPA, via ShutterstockIn addition to small businesses, some vulnerable privately held companies that do have access to corporate credit markets are already grappling with higher interest costs. Backed by private-equity investors, who typically buy out businesses and load them with debt to extract financial profits, these companies borrow in the leveraged loan market, where borrowing typically comes with a floating interest rate that rises and falls broadly in line with the Fed’s adjustments.Moody’s maintains a list of companies rated B3 negative and below, a very low credit rating reserved for companies in financial distress. Almost 80 percent of the companies on this list are private-equity-backed leveraged buyouts.Some of these borrowers have sought creative ways to extend the terms of their debt, or to avoid paying interest until the economic climate brightens.The used-car seller Carvana — backed by the private-equity giant Apollo Global Management — renegotiated its debt this year to do just that, allowing its management to cut losses in the third quarter, not including the mounting interest costs that it is deferring.Leaders of at-risk companies will be hoping that a serene mix of economic news is on the horizon — with inflation fading substantially as overall economic growth holds steady, allowing Fed officials to end the rate-increase cycle or even cut rates slightly.Some recent research provides a bit of that hope.In September, staff economists at the Federal Reserve Bank of Chicago published a model forecast indicating that “inflation will return to near the Fed’s target by mid-2024” without a major economic contraction. If that comes to pass, lower interest rates for companies in need of fresh funds could be coming to the rescue much sooner than previously expected.Few, at this point, see that as a guarantee, including Ms. Sheth at Moody’s.“Companies had a lot of things going for them that may be running out next year,” she said.Emily Flitter More

More stories

  • 125 Shares189 Views

    in Economy

    Economist Austan Goolsbee Is Named to Lead the Chicago Fed

    by

    A longtime University of Chicago economist who served in the Obama White House will be president of one of the Fed’s 12 regional districts.The Federal Reserve Bank of Chicago said on Thursday that Austan D. Goolsbee will become its next president, taking a seat at the central bank’s policy-setting table as officials work to bring down the fastest inflation in decades.Mr. Goolsbee, who was a member and later chairman of the Council of Economic Advisers during the Obama administration between 2009 and 2011, has long been a faculty member at the University of Chicago’s Booth School of Business. He has a doctorate in economics from the Massachusetts Institute of Technology, and studied for his undergraduate degree at Yale.He will replace Charles Evans, who has been in the role since 2007 and at the Chicago Fed since 1991 and is retiring.The Chicago Fed district is made up of Iowa and most of Illinois, Indiana, Michigan and Wisconsin. The Fed’s 12 presidents oversee large staffs of researchers and bank supervisors and vote on monetary policy on a rotating basis.Mr. Goolsbee will vote on policy in 2023, meaning that he will be an important voice at the table as the Fed continues its effort to wrangle rapid inflation and tries to decide just how aggressive a policy response that will require. He is expected to start on Jan. 9.“These have been challenging, unprecedented times for the economy,” Mr. Goolsbee said in the statement from the Chicago Fed announcing the decision. “The bank has an important role to play.”Mr. Goolsbee warned in an opinion column last year that using past economic experiences to understand pandemic-era inflation and labor market changes would be a mistake.“Past business cycles look nothing like what the United States has gone through in the pandemic,” he wrote. “The most interesting questions aren’t really about recession and recovery. They center on whether any of the pandemic changes will last.”He also participates in surveys of economic experts carried out by the Chicago Booth Initiative on Global Markets, which offers a snapshot of some of his thoughts on relevant topics including inflation and the growing divide between the rich and the poor. Early this year, he noted that corporate profit margins have increased — a sign that companies are increasing prices by more than their costs are climbing — but said that they had not shot up enough to explain inflation. In response to a question about whether price controls could be used to contain prices, he wrote: “Just stop. Seriously.”In another Booth poll, asked if “the increasing share of income and wealth among the richest Americans is a major threat to capitalism,” he responded: “Duh.”While many economists responded to Mr. Goolsbee’s appointment positively, there was some backlash. Senator Bob Menendez, a Democrat from New Jersey, has been pushing the Fed to appoint Latino leaders. He said the selection process — which is run by the local business and nonprofit leaders who sit on a regional bank’s board — is antiquated and opaque.The result risks “perpetuating a legacy that has shut out Latinos from the upper echelons of leadership at the Fed,” Mr. Menendez said in a statement. More

  • 138 Shares169 Views

    in Economy

    A Fed Pivot? Not Yet, Policymakers Suggest, as Rapid Inflation Lingers.

    by

    Federal Reserve officials on Tuesday made clear that they expected to continue raising rates to try to choke off the most rapid inflation in decades, putting them at odds with investors who had become more sanguine about the outlook for interest rate moves.Stocks prices rose following the Fed’s meeting last week, as investors celebrated what some interpreted as a pivot: Jerome H. Powell, the Fed chair, said the central bank would begin making rate decisions on a meeting-by-meeting basis, which Wall Street took as a signal that its rate moves might soon slow down.But a chorus of Fed officials has since made clear that a lurch away from rate increases is not yet in the cards.Mary C. Daly, the president of the Federal Reserve Bank of San Francisco, said in an interview on LinkedIn on Tuesday that the Fed was “nowhere near” done raising interest rates. Charles L. Evans, the president of the Federal Reserve Bank of Chicago, told reporters that he would favor a half- or even a three-quarter-point rate increase in September.Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, said in an interview late last week that he did not understand why markets were dialing back their expectations for Fed rate increases.8 Signs That the Economy Is Losing SteamCard 1 of 9Worrying outlook. More

  • 125 Shares159 Views

    in Economy

    Why Are There So Few Black Economists at the Fed?

    by

    #masthead-section-label, #masthead-bar-one { display: none }The Jobs CrisisCurrent Unemployment RateWhen the Checks Run OutThe Economy in 9 ChartsThe First 6 MonthsJ. Monroe Gamble IV pushed for changes to the hiring process at the Federal Reserve Bank of San Francisco.Credit…Christopher Smith for The New York TimesSkip to contentSkip to site indexWhy Are There So Few Black Economists at the Fed?Monroe Gamble became the San Francisco Fed’s first Black research assistant in 2018. His path shows why fixing a striking diversity shortfall will take commitment.J. Monroe Gamble IV pushed for changes to the hiring process at the Federal Reserve Bank of San Francisco.Credit…Christopher Smith for The New York TimesSupported byContinue reading the main storyFeb. 2, 2021, 5:00 a.m. ETWASHINGTON — J. Monroe Gamble IV was the first Black research assistant to work at the Federal Reserve Bank of San Francisco. He started in 2018.That one data point speaks to a broader reality: Even as America’s central bank dedicates research and attention to racial economic outcomes and publicly champions inclusion, it has had a poor record of building a work force that looks like the population it is meant to serve.Many parts of the Fed system, which includes the Federal Reserve Board in Washington and 12 regional banks, began to concentrate more intently on diversifying their heavily white economics staffs only within the last decade, prompted in part by the 2010 Dodd Frank Act, which pushed the board to hire more broadly. When it comes to employing Black economists in particular, the central bank still falls short.Officials have often blamed the pipeline — Ph.D. economists are heavily white and Asian — but a New York Times analysis suggests the issue goes even beyond that. Black people are less represented within the Fed than in the field as a whole. Only two of the 417 economists, or 0.5 percent, on staff at the Fed’s board in Washington were Black, as of data the Fed provided last month. Black people make up 13 percent of America’s population and 3 to 4 percent of the U.S. citizens and permanent residents who graduate as Ph.D. economists each year.Practices that favor job candidates with similar life experiences and those from elite economics programs, which are often heavily white, have sometimes prevented diverse hiring, current and former employees said. A brash culture can make some parts of the central bank unwelcoming, which can lower retention. More