High interest rates are risky business
The Federal Reserve lifted its key interest rate by a quarter of a percentage point Wednesday, pushing it to the highest level since 2001. Now, it’s one thing to raise interest rates, but it’s another to keep them raised.
Prodded by the Fed’s efforts to subdue inflation, interest rates across the economy have climbed dramatically since early 2022. We don’t know how long rates will stay high; some forecasting firms say they could be a lot lower by the end of 2024.
But we do know that the longer rates stay high, the harder it is for a lot of businesses to do business. For some of them, it could even be hard to stay in business.
“If I’m a vehicle producer or I’m in the housing industry or I sell appliances, then the higher interest rates raise the cost of borrowing for consumers, they buy less and it hurts my business,” said Mark Zandi, chief economist at Moody’s Analytics.
It’s hard for consumers to take out loans. Delinquencies on auto loans, for example, have been rising sharply since the Fed started boosting rates last year. But it’s not just that businesses suffer because their customers do; businesses are directly affected by high rates because a lot of them take out bank loans.
“Because most bank loans are actually variable-interest-rate loans, these high interest rates today will mean that firms will be immediately facing higher borrowing costs on these financing needs,” said Simon Gilchrist, a professor of economics at New York University.
That’s exactly what’s happening, per Nick Kraemer, head of ratings performance analytics at S&P Global Ratings. “We have seen the amount of cash that corporates are paying on interest payments jump about 15% globally, which is well beyond what we’ve seen in the last several years.”
Business credit ratings are getting worse too. “We are seeing more downgrades, particularly in the U.S.,” Kraemer added.
Downgrades are happening more to businesses that didn’t have very high ratings to begin with. Defaults are rising as well, although they’re coming off a very low level. “And we do anticipate that will increase over the next 12 months or so,” Kraemer added.
He expects corporate defaults to rise from around 3% now to 4.25% next year. The businesses most at risk are those that owe the most, per Moody’s Zandi.
“Some businesses probably miscalculated, took on too much debt in the context of the weakening economy, and many of them will go bankrupt and some will fail,” he said.
The longer rates stay high, the more companies will feel the weight of their debt.
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