It appears we were correct several weeks ago when we wrote that the Fed will maintain elevated interest rates for longer than markets expect. What are the repercussions for business?
A persistently higher interest rate environment will expose hidden zombie companies much like the dry Paluxy River bed in Texas recently exposed dinosaur tracks. However, investors already know which companies are zombie companies for the most part.
Perhaps more important is the impact higher interest rates will have on healthy companies that carry debt. The higher interest rate environment will not only impact companies with floating rate debt, but also companies that have fixed rate debt when that debt matures and needs to be rolled over (many companies believed they would be able to roll over debt at negative real rates in perpetuity).
The 7-Year Treasury yield for example has more than doubled since the beginning of the year from 1.55% to 3.14%, meaning that the interest expense for new corporate credit issues that mimic the 7-year increased by 103% over the year-to-date period. For every $1 billion of principal issued, annual interest expense grew from $15.5 million to $31.4 million. Those incremental dollars that get allocated to interest expense are not allocated to productive means such as R&D expense or Product Development – two critical areas for driving long-term growth within Technology companies. Sales & Marketing will also be negatively impacted by higher interest expense. Therefore, it becomes clear how higher interest rates can strangle Revenue Growth, Employment and ultimately GDP to say nothing of the cost of capital.