As the Federal Reserve continues to hike interest rates to combat inflation, some businesses are sitting on the sidelines, amid growing concerns about recession, while others are finding opportunity.
On July 27, the Federal Open Market Committee (FOMC) raised the Federal Funds rate—the overnight interest rate that banks charge each other to borrow money—by 75 basis points (three-quarters of a percent) to a target range of 2.25% to 2.5%. It is the fourth rate hike this year, with three more hikes expected before year-end.
Rate hikes increase the cost of borrowing, which means that businesses will pay more interest on the debt they owe, likely reducing their net income, explained Bank of Texas CEO Norm Bagwell.
The rate hikes come as no surprise, as the Fed's Open Market Committee has openly communicated their plans. As Bagwell said, "Businesses have known for some time that rates would rise significantly in 2022." But the speed of the increases has some business owners and economists concerned that tightening monetary policy too fast could lead to a recession.
"Fifty basis points is already a big number, 75 is huge, 100 is almost unheard of," said BOK Financial® Chief Investment Officer Brian Henderson, referring to the fact that, leading up to the most recent FOMC meeting, some analysts pondered whether the Fed would hike the Federal Funds rate by a full percentage point.
Catching up with inflation
The Fed calculates its rates incrementally, based on three main factors: the current state of monetary policy, what the market expects the FOMC will do and economic indicators such as month-over-month inflation and long-term inflation expectations.
"With current year-over-year inflation data running at 40-year highs against a 2% longer-term target, and the Federal Funds rate having started at basically zero, the Fed has had to move in larger increments in the beginning to get the Federal Funds target to neutral—around 2.25 to 2.5%—as soon as possible," Henderson explained.
Some businesses anticipating higher interest rates and persistently high inflation have prepared accordingly, and some are even benefitting from the higher rate environment, experts said.
"We have seen clients make moves to battle the inflation side of the equation—moving debt to fixed rates, interest rate hedging, investing free deposits and paying down debt," Bagwell said. "Conversely, we have seen many clients purchase facilities or finance owner-occupied real estate, giving them the ability to control their rent and facility costs and benefit from real estate as an inflation hedge."
"There have always been businesses that excel during tough times," agreed Bruce Guest, regional commercial banking manager for BOK Financial, covering Arizona, Colorado and Oklahoma. Businesses that have limited borrowing needs—for instance, those that can pay cash for equipment—will be less impacted by the rising rate environment and it may even offer an opportunity for them, he said.
"If they can hold their costs in line because they're not paying additional costs tomorrow and hold their prices longer, they potentially can take market share away from competition that has to use financing to grow their business," Guest explained.
Recession fears linger
Meanwhile, some businesses are sitting on the sidelines amid questions of whether a recession is on the horizon and, if there is one, how long it would last, Guest said. In fact, one recent study found that 93% of small business owners are worried that the U.S. will enter a recession in the next six months.
One thing is certain, Henderson said. As the Fed continues to raise rates, the economy will slow. "It's going to be slowing down all year long and, whether we're in a recession or not, it's going to be very slow and close to feeling like a recession, especially if the Federal Reserve is actually able to hike rates as much as what it's guiding to."
But in the end, if the rate hikes do what's intended, prices will come down. In Bagwell's words: "The number one goal for everyone—consumers, business and government—is to tame inflation. If rate hikes are the path to accomplish that, I think everyone understands the importance and potential pain that may come along the way."