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What the Fed’s Rate Hike Means for Middle-market Companies

 6 min read / 

As everyone bar those living under a rock will have heard, the Federal Reserve decided to increase interest rates by 25 basis points on Wednesday. The Fed’s rate hike took the federal funds rate from 0.75% to 1% – a level it has not reached since October 2008. While rates remain near historic lows, the Fed signalled its plan continue raising rates over the near- to mid-term.

While the rate hike could be seen as a signal that the economy will continue to grow, the Fed’s outlook is actually less hawkish than many anticipated – and this has not gone unnoticed. In a letter to investors, Jan Hatzius, Chief Economist at Goldman Sachs, noted that Goldman’s “Financial Conditions Index (FCI) eased by an estimated 14 basis points on the day … and is now considerably easier than in early December, despite two funds rate hikes in the meantime.”

Source: Goldman Sachs

“Our FCI has reversed most of the recent tightening” – Goldman Sachs

While Mr Hatzius remained confident that the Fed would continue to raise rates over the course of the year, this was not the result that most analysts expected prior to the decision. In fact, the FCI usually tightens following a rate hike.

Unpacking the Fed’s Rate Hike

Thursday’s reaction to the news invites the question: what’s going on? There are three possible answers, and none of them are good for middle-market companies.

First is the possibility the that Fed has been too dovish for too long in its attempts to normalise rates, which could force the central bank towards overcompensation – potentially increasing the frequency of rate increases, or some other measure that could cause a tightening.  Such a situation would put pressure on middle-market companies as they seek to contain cost pressures.

Is Money Heating Up?

2% The Fed’s medium-term inflation expectation

Second is the possibility that inflation is gaining momentum. In fact, the Fed pointed to this in their announcement, noting that “inflation will stabilise around 2% over the medium-term.” While the Fed continues its conservative stance, others are concerned that inflation is gaining pace and believe that it could accelerate to 2.5% by the end of the year.

Given that the most recent consensus report from Thompson Reuters puts US 2017 GDP growth at 2.32%, the result could be a net negative for companies large and small. The graph below shows how forecasts for this year’s overall US growth has changed over the last few months:

2017 US GDP Growth Revisions – Consensus Forecasts (Source: Thomson Reuters)

In fact, the same forecast expects industrial production to grow at a much slower rate than consumer spending. While this is good news for retailers and wholesalers, it could be a sign of continued headwinds for manufacturing companies – many of whom are in the middle market.

Finally, there is the very real possibility that hot money is driving the market to breaking point and that a correction could be on the way.  This view is shared by a growing number of economists. In a recent article in The Atlantic, Ben Herzon, a senior economist at the St Louis-based Macroeconomic Advisers, noted that the economy is in the midst of “a really long expansion.” While this does not mean a correction is imminent, the post-election market rally is pushing asset prices towards what many believe to be unsustainable levels.

Where Does This Leave Middle-market Companies?

While the near-term impact of a 25-basis-point increase in rates is minimal, the longer trend points to the effective federal funds rate eclipsing 2% by some time in 2018. This would have a dramatic impact on the cost of capital for companies in the middle market – especially as they seek to roll over their rapidly maturing debt.

US Middle Market Debt (Source: Blackrock)

Assuming the Fed enacts two additional 25-basis-point hikes this year – a rather conservative estimate, as some economists believe three rate hikes are in store – the impact on borrowing costs would be somewhere between 1% and 1.25% for borrowers with ‘AAA’ credit ratings.

Granted, the impact of a 1% hike for a company with ‘AAA’ credit is marginal. However, a ‘BBB’ rated company could be looking at an additional 2% to 2.5% on top of current rates. To put this into, perspective a ‘BBB’ rated company with $100m in revenue seeking to borrow $10m would have to pay nearly $200,000 in additional finance costs. This would severely impact profitability.

That being said, expected rate increases are unlikely to have a “major impact on direct lending activity”, as Elvire Perrin argues. If anything, the increases might cause more money to flow into the corporate debt market.

In addition, a clear rate direction will help middle-market companies to more accurately forecast their cost of capital for the next 12 to 18 months, allowing them to make better decisions about what they need to do with their debt portfolio.

How Ford Used Debt to Survive a Tsunami

The Great Recession hit American automakers particularly hard. It forced General Motors into bankruptcy and the newly liberated Chrysler was sold to Fiat just to stay running, while the Federal Government needed to step in with a massive bailout package to stop the entire industry imploding under its own weight.

The outlier was Ford. The company neither sought protection from the bankruptcy courts or the Government. Instead, Ford’s leaders saw that a crisis was looming and decided to take out nearly $24bn in debt before the markets seized up.

While the unconventional move raised eyebrows at the time, it turned out to be the company’s salvation as it gave the automaker the ammunition they needed to survive one of the darkest moments in the history of the American auto industry.

The Lesson? Lever Up or Regret It

The era of cheap money is coming to an end. Roughly eight years into the current period of economic expansion, it is only a matter of time before the economy begins to contract. This is not to say that a recession will happen next week or next quarter. However, increasing inflationary pressure, as well as uncertainty in the markets, could prove too much.

The Fed has set a clear signal that the cost of capital will continue to increase. Middle-market executives should take heed by securing structured credit lines at rates which will be considered inexpensive on a lookback basis. Even if they avoid touching the funds, having access to these credit lines will allow for more flexibility going forward.

 

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Americas

Bulletproof Clothing: How US Fashion Is Going Ballistic

 2 min read / 

Bulletproof Clothing

As the US continues to allow civilians to carry weapons and gun violence becomes more of a concern, an increasing number of bulletproof apparel retailers are emerging across the country. Their target clients? The average Joe. Or at least those who can afford the hefty price tags associated with the “exotic” new fashion segment.

Miguel Caballero, a Colombian designer, sells his bulletproof blazers for 4,343.50 euros, and his tank tops for 2,023 euros. At a lower price, but still too high for most people, Joe Curran, who owns BulletBlocker, sells his bulletproof leather jacket for $875 and bulletproof classic two-piece suit for $1,200.

Source: Miguel Caballero

Caballero said that his clients include world leaders from South America and the Middle East, and international businessmen. Damien Ross, another manufacturer of bulletproof clothing, said that his clients are mostly college-educated, professional men, between the ages of 34 and 75.

Ross said:

“They [clients] see what’s happening on the news, and, any time they’re in a crowd or an area that can be prone to attack, they are concerned.”

Source: Bullet Blocker

Body armour manufacturing is a $465 million-a-year industry in the US, according to a report in August from Market Research. The retailers, who mostly entered the industry because of the surge in gun violence taking place around them, are presenting upscale bulletproof clothing, from blazers to tank tops.

Owning body armour is completely legal, and does not require a special permit or background check. However, guidelines vary from state-to-state, and felons are not able to purchase it.

Keep reading |  2 min read

Americas

Trump Promises Tax Cut “for Christmas”

 2 min read / 

Trump Tax Cut

US President Donald Trump has said the country is “just days away” from the biggest tax reform since the Reagan administration.  Speaking at the White House, Trump said he was close to fulfilling his campaign promise “to cut taxes for the everyday working American” and that he wanted “to give [the American people] a giant tax cut for Christmas”.

This week, Republicans and Democrats have reached an agreement on the two different tax bills that were rapidly pushed through Congress last month. If passed, it will be the first significant piece of legislation passed by the Trump administration. The compromise reached by both parties will see a corporate tax cut from 35% to 21% and cap the top tax rate for individuals at 37%.

Following a Democrat victory in Alabama’s senatorial election on Tuesday, the GOP was left with a majority of just 51 out of 100 in the upper house. As such, the Republicans are pushing for a vote on the tax bill for early next week, before the newly-elected Doug Jones can take his seat in Congress.

Tax reform was a keystone in Trump’s electoral campaign and success here would allow other tax deductions at a state and local level to work. It would also give Trump a chance to reverse his low approval ratings which have averaged at 39%, which makes him one of the most unpopular Presidents in the history of political polling.

Keep reading |  2 min read

Americas

Venezuelan Digital Currency Backed by Oil

 2 min read / 

Venezuelan Digital Currency

The Story

Venezuela has announced plans to launch a digital currency, “the petro”, backed by the country’s oil and mineral reserves. The petro aims to help ease the country’s monetary crisis but sceptics claim the proposal has no credibility and will not help those in extreme need.

Why It’s Important


source: tradingeconomics.com

Hyperinflation has eroded the Venezuelan bolivia’s value by 97% this year, making imports incredibly expensive and causing many to abandon trust in the currency. The country’s oil reserves made up 95% of its exports in 2016, while oil and gas extraction accounted for 25% of GDP. Rich supplies of resources provide some initial credibility to the proposal, but President Maduro’s questionable track record when it comes to monetary policy is making many sceptical about the proposal. His currency controls and money printing have only added to the monetary crisis. Maduro has not announced when the digital currency would come into use or any details regarding how the country would create such a system.

Opposition leaders argue the country’s shortages of food and medication are far more pressing and that the digital currency will not address this. The digital currency may provide a more trusted medium of exchange, but it is unlikely to help those in excessive poverty.

Keep reading |  2 min read

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