Normally, when the Federal Reserve raises interest rates repeatedly over a short period of time, it would be expected to cause a significant slowdown in the economy, if not a full-blown recession. This is what both Fed chairman Jay Powell and Wall Street have been anticipating. However, according to Albert Edwards, a renowned strategist at Societe Generale, there may be another explanation behind the current situation. Edwards points to a chart created by Jitesh Kumar, a number cruncher at SG, which he claims to be “one of the maddest macro charts” he has seen in years.
In essence, Edwards argues that the Fed’s rate hikes may actually be exacerbating the problem instead of alleviating it. This is because a large portion of corporate America’s debt, much like the debt of many homeowners, was locked in at low fixed interest rates during the years 2020 and 2021. As a result, raising interest rates has little to no impact on their cost of debt.
Interestingly, companies are now earning higher interest on their cash holdings. Edwards highlights that the U.S. corporate sector is heavily reliant on borrowing and refers to data on corporate debt published by the Federal Reserve. He points out that typically, as interest rates rise, so do net debt payments, which in turn squeeze profit margins and slow down the economy. However, this time is different. Corporate net interest payments have actually plummeted.
In conclusion, it appears that the Fed’s intentions of slowing down the economy through interest rate hikes may not be having the desired effect, and instead could be reinforcing the imbalance in corporate debt. This unexpected turn of events demands further analysis and consideration as we navigate through this challenging economic landscape.
Corporations’ Interest Payments Plummet as Profits Soar
According to the U.S. Bureau of Economic Analysis, corporations’ net interest payments have seen a staggering 25% drop from their peak. In fact, they are currently at their lowest level in the past 60 years when considering post-tax economic profits.
A recent analysis suggests that a significant portion of the massive, fixed-rate borrowings during 2020 and 2021 still remain on company balance sheets. Surprisingly, companies have managed to turn the tables and benefit from higher rates instead of suffering a deduction of more than 10% from profits, which is typically expected.
Essentially, corporations have employed a reverse yield curve strategy by borrowing funds at the historically low long-term rates of 2020 and 2021. They have then gone on to lend that money, either to the U.S. government through Treasury bills or other savings vehicles, at higher short-term rates.
The implications of this phenomenon are mind-boggling, as highlighted by Edwards: “It is indeed a mad, mad world.”
However, what remains uncertain for now is the fate of corporations’ longer-term, fixed-rate loans once they come due. It is highly likely that many will require refinancing at higher rates. If this analysis holds true, it suggests that trouble may have been temporarily postponed rather than completely avoided.