How Firms Have Dodged The Worst Impacts From Inflation And Rate Hikes

How Firms Have Dodged The Worst Impacts From Inflation And Rate Hikes
Stéphane Renevier, CFA

7 months ago2 mins

With inflation rocketing and interest rates zooming, you'd think corporate America would be grabbing their parachutes. But what’s unfolded has been quite the contrary.

Even with the Federal Reserve (the Fed) aggressively cranking up rates, companies' net interest payments (the interest paid on debt minus what’s earned on cash) have taken a surprising dip (red line). And that hasn’t been offset by lower sales or slimmer profit margins either: when you look at those payments as a percentage of profits (black line), US companies are shelling out a whole 5% less than they were just a year ago.

And there are two big reasons for this:

Balance sheet magic: Many businesses, during the pandemic's low-interest-rate party, locked in those sweet borrowing costs. Even as rates have shot higher, these businesses have been lounging comfortably with their cost-effective financing. At the same time, they’ve put their massive cash reserves (a lot of it borrowed at those enviable rates) to work at juicier rates. It's like they've pulled a bank move, borrowing long-term on the cheap and lending short-term for more. It’s no wonder their net interest payments are down.

Price tag tango: Businesses knew that consumers had beefed up their savings during the pandemic, and they spotted an opportunity there. They smartly offset their own rising costs by adjusting consumer price tags. But get this: Albert Edwards, one of Wall Street's aces, thinks companies weren't just covering their higher costs. Sensing that consumers expected price increases, they cranked up prices to a whole new level – Edwards calls it "greedflation". And this little maneuver helps explain why profits have remained so resilient.

The upshot is this: companies have been hiking prices, maintaining low financing costs, and raking in returns on cash stashes. And it’s made a big difference: profit stability means they have mostly sidestepped the need for massive layoffs, saving the economy from potential turbulence.

But don't get too comfy. This fancy footwork has an expiration date. Consumers have their limits with price surges. And eventually, factors like dwindling confidence in the economy, the potential for job losses, and an eroding savings pile could curb their spending habits. As for companies, the day will come when they'll need to refinance that debt, probably at those higher rates. Plus, with inflation falling, new price hikes won't fly with consumers, and that could slim down those margins. To put it simply: corporate America might've hit snooze on the effects of the Fed's rate hikes, but reality's alarm will ring.

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