The Federal Reserve’s rate hiking cycle that commenced in early 2022 lifted the cost of capital for corporations and individuals. Importantly, however, the impact of higher rates often has lagged effects, particularly for those who are able to lock in low debt financing for many years.
When the Federal Reserve dropped rates in response to the pandemic, many corporations used this as an opportunity to lock in long-term, fixed rate debt financing at a low rate — a more common source of financing for large-cap companies as we show in our accompanying piece. Meanwhile, as rates have risen over the last two years, companies are earning higher yields on cash holdings. As a result, net interest payments from corporations have come down meaningfully since the 2019 peak, as we show in the chart. More recently, that downward trend has stalled as new investment has to be financed at higher rates. The same can be said for individuals who have a traditional 30-year fixed rate mortgage. Although mortgage rates are north of 7% today, the effective interest rate on mortgage debt outstanding is less than 4% but trending higher as new mortgages are established at higher rates.
What’s the bottom line? Changes in the federal funds rate take time to impact the real economy, as monetary policy has long and variable lags. Corporations’ and individuals’ ability to lock in low rate debt have helped to blunt the impact of higher rates, but until rates come down, the cost of capital remains restrictive, and is likely to continue to curb demand in the near term.
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