It’s easy to think of lower interest rates as a panacea. After all, almost everyone is affected to some degree by the cost of borrowing. When the Federal Reserve cuts its benchmark interest rate — as it’s expected to do this week for the first time since the pandemic — it makes credit cheaper for consumers and businesses. Cheaper debt means businesses can spend more to grow, just as consumers might be able to buy bigger homes with lower mortgage rates.
But there is a complex and somewhat unpredictable interplay between interest rates and the business world. Lower rates support the economy, but for businesses and their investors, they do not always have unalloyed positive effects.
Here’s what U.S. businesses can expect when the Fed cuts rates:
For markets, it’s all about “why.”
All else equal, low rates are good for the stock market. When investors assess the value of a stock, they tend to estimate a higher number when interest rates fall because of a common valuation principle called discounting, which states that a company’s future cash flows and costs become more attractive under low-rate conditions.
Fed officials are expected to cut rates by a quarter to a half percentage point at their meeting this week. In practice, analysts say, the reason for the rate cut matters more than the timing or size of the cut.
If the economy falters and forces the Fed to cut rates quickly, that could be a headwind for the stock market. A gradual return to more normal rates — at least in the context of recent decades — is less likely to dent corporate profits the way an economic slowdown would.
“It’s not so much when they cut rates and how quickly they do it, but why they do it,” said Greg Boutle, head of U.S. equity and derivatives strategy at BNP Paribas.
A bit of history: The Fed began cutting rates in September 2007, at the very beginning of the financial crisis. Over the next 12 months, the S&P 500 index fell more than 20%. But the rate cuts of 1995 and 1998 were accompanied by a surge in stocks.
For now, economists agree that the economy will remain resilient, which supports high stock market valuations. But investors still face many uncertainties about global growth, geopolitics and the upcoming presidential election.
Bet on mixed news for lenders.
Few businesses are more sensitive to interest rates than banks. That’s because lenders typically make money on the difference between what they pay depositors and what they charge borrowers, such as home buyers who need a mortgage and trading firms that want leverage to boost their bets.
That difference is known as a spread, and higher rates allow banks to collect a wider spread. No wonder stocks of the biggest banks fell last week when executives at major institutions like JPMorgan Chase warned that analysts were too optimistic about how lenders would fare if rates fell and spreads narrowed.
By contrast, big investment banks like Goldman Sachs and Morgan Stanley, as well as some corporate law firms, are chasing fees for the advice they can collect on mergers and acquisitions, when one company buys another. Lower rates allow those companies — or the private equity firms that back them — to take out cheaper loans to support those acquisitions and increase the chances of deals closing.
Keep in mind, though, that while mergers can be profitable for investors and corporate executives whose contracts provide for payments based on the deals, rank-and-file employees could see their jobs disappear as part of the “synergies” or cost-cutting efforts needed to repay the loans that made the deals possible.
Commercial owners will accept any help they can get.
While the Fed’s benchmark rate doesn’t directly affect residential or commercial mortgage rates (it can take months for lower interest rates to trickle in), homeowners are heavily reliant on debt and will welcome any relief in the form of refinancing.
But it will take more than a rate cut to save the struggling office market. Many of the most distressed (i.e., empty) commercial buildings are in relatively unpopular downtown neighborhoods, and with many employees continuing to work remotely, it’s unclear whether these spaces will ever become financially viable again.
And if lower rates allow more commercial properties to change hands at lower prices, it could force large landlords to write down the value of comparable properties in their portfolios. Many landlords and investors resist that, arguing that the lack of recent comparable transactions makes the exercise futile.
A recovery in activity stimulated by lower rates could lead to a cascade of declines in real estate values.
This is the beginning of a borrowing frenzy for businesses.
If companies can borrow more cheaply, the savings should allow them to spend more on hiring, acquisitions or paying shareholders through share buybacks and dividends. Such spending is one way that lower interest rates could ripple through the global economy.
But if the rate cuts are accompanied by growing macroeconomic concerns, lenders may be reluctant to extend credit to indebted and distressed companies. In that case, the interest rates offered may not change much.
For now, those concerns remain on hold, and the prospect of a rate cut has already rekindled appetite for loans among bond investors seeking higher rates — and higher yields — before the Fed starts cutting rates. The move has been welcomed by U.S. companies, particularly those with bonds maturing in the near future or borrowers with lower credit ratings.
Sales of riskier high-yield bonds are growing at a faster pace than in the past two years, with nearly $200 billion in borrowing in 2024 so far, according to data provider Refinitiv. Pitchbook, another data provider, also noted a wave of borrowing in August and September in bond and loan markets.
Everyone tries to predict the economy, but no one succeeds.
Let’s be clear: The fact that the Fed is likely to cut interest rates is generally good news, as it is the clearest sign yet that inflation is under control.
Price increases have been slowing for years. Headline consumer price index inflation stood at 2.5% in the year to August, down from a peak of 9.1% in the summer of 2022.
With inflation approaching a normal pace, the Fed can now focus more on its other goal: maintaining a strong jobs market. By gradually lowering interest rates, the Fed hopes to slow inflation without crippling the jobs market.
So far, consumer spending is holding up and hiring is continuing, albeit at a slower pace than in 2022 and 2023. But the unemployment rate has risen over the past year, warning that the Fed may be overdoing its efforts to cool the economy.
Fed Governor Christopher Waller acknowledged in a recent speech that determining the ideal speed to cut interest rates to achieve a so-called soft landing could be a challenge.
A slower pace of rate cuts would carry “the risk of going too slowly and jeopardizing the labor market,” he said. But, he added, “a faster rate cut increases the chances of a soft landing, but at the risk of going too far in cutting rates.”
