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Advisors, CEOs, Private Equity

The Dubious and Precarious State of the Interest Rate

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2016 has witnessed some of the most bizarre, curious, and unprecedented decisions on the part of central bankers and the issuers of government debt. In this age of information and hyper-technology, we demand instant gratification at all turns and we insist on waiting for nothing.

We simply want it now, no matter what “it” is.

Thanks to central bankers around the world, we are able to borrow money at historically low rates.  So today, it is that much easier to purchase whatever we desire, exactly when we want it.

This reality has led to current state of the interest rate in the modern world, best described in two words:  Dubious and Precarious.

Consider some of these recent events from around the globe:

  • As many as fifteen central banks have offered overnight lending at negative interest rates in 2016. This led to a situation in summer 2016 in which over $10 trillion in total negative-yielding government bonds were available worldwide, amounting to over ¼ of all sovereign debt being offered. Recent weeks have seen a sell-off in government debt, causing some yields to rise.
  • Italy, a nation in the early stages of a full-blown banking crisis, with a declining population and a rather weak economy, is able to borrow money by selling government bonds at just over 1%, and is strongly considering offering government bonds with a duration of 50 years.
  • The British government announced in August that it would begin buying certain corporate bonds to affect even lower borrowing costs for several select large British companies. Lower than what? The average British corporate bond has coupons of well under 5% and large A-rated offerings are well under 3%. How will it select the bonds which it purchases? No one really knows. What will be the unintended consequences of a central bank’s unprecedented decision to select winners and losers in the corporate bond market?
  • Japan is buying its own government bonds at such an accelerated rate in an effort to keep rates low and pump liquidity into its flagging economy that it is quite literally running out of bonds to purchase (in a different era, this would be the equivalent of printing money fast enough to wear out the printing press).

The Impending Rate Hike

The aftermath of 2008’s financial crisis has had a lasting effect on the U.S. economy and led many to question our economic stability looking forward. The displacement of jobs, the loss of individuals’ retirement funds and savings, and the overall state of our country’s economy amassed to create a recession in our country that was the most profound since the Great Depression of the 1930s.

Fast forward eight years and policymakers are still nervous about spurring another incident of this magnitude.  The Federal Reserve continues to prolong the decision to hike interest rates, in order to ensure that our country is economically strong enough to support an increase.

In the last few months, however, the general consensus among policymakers and pundits is that it’s time to rip the Band-Aid off. However, the question remains:  when will this rate hike take place?

The most recent meeting of the Federal Reserve concluded with nearly an even split between those in favor and those against raising interest rates as early as next month. A strong case can be made for either side. Those against a hike, point to an employment rate that has not significantly increased and an economy that saw a decrease in the production of goods and services.  Those in favor point to a return of some stability in oil prices and the strong performance of the U.S. dollar, and argue that a raise in interest rates is needed to encourage saving rather than spending.

The fact of the matter is that the Federal Reserve will raise interest rates at some point in the future. The question is whether or not this will help or hurt our economy if not done at the appropriate time.

Implications for Borrowers

While the interest rate may have become nothing more than a signpost on the road to uncertainty, we are still able to spot the obvious beneficiaries of the current scenario: borrowers. There may have never been a better time to be a corporate borrower, and all corporate borrowers should be taking advantage of the current landscape.

A consequence of the prolonged period of extremely low interest rates has been the formation of numerous new private debt funds as yield-hungry investors seek some type of return on capital.  More lenders than ever have led to an oversupply of cheap financing. For companies seeking leverage or companies with flat financial performance alike, there may have never been a better time to borrow money.  And our strong feeling is that for borrowers, now is the time to act. Even active participants in the debt markets have no way of knowing when the current friendly lending environment might turn unfriendly. Future periods will eventually see higher borrowing costs and could quite possibly see further market and regulatory constraints to lenders.

The most efficient way to seek debt capital is by hiring a trained professional advisor who can help refine your company’s message and navigate the ups and downs of the market and the nuances of each lender and each type of debt.

The fall of each year brings about a call to attention for any corporate borrower seeking to complete a deal by year-end. The clock is ticking to prepare a debt offering with any chance of completing and fund the deal before December 31. However, given today’s accommodating debt markets and future uncertainty, there is an even greater level of impetus to market participants to seek financing or refinancing now. Quality borrowers can come close to naming their price and structure, and less than quality borrowers still have an open window to getting their deal across the finish line. Such a borrower-friendly market may not last much longer.

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