Market News

How Rising Rates Fuel the Wealth of Big Companies: A Comprehensive Analysis

Analysis, Big, Companies, Comprehensive, Fuel, Rates, Rising, Wealth

SEO Friendly News Article

The Winners from Higher Interest Rates

The Federal Reserve jacked up interest rates to slow the red-hot economy. At some of the biggest and most secure companies, the moves had the opposite of the intended effect, boosting their profits and spending power.

High-Quality Borrowers Benefit

  • High-quality borrowers locked in low interest rates around the pandemic.
  • Higher rates have little immediate impact on their borrowing costs.
  • They earn more on their cash piles straight away.

For the Fed, the dynamic blunts the impact of rate increases, which are meant to work in part by persuading big companies that capital is more expensive so they should pull in their horns. Companies that find they have more money thanks to higher rates can raise dividends, invest more and be more willing to pay up for the right staff, all supporting the economy.

Microsoft’s Experience

Take Microsoft, the world’s second-most valuable company. It has more cash and short-term investments than debt, so it was never going to be threatened by higher rates. But it has also fixed its borrowing costs: It paid exactly the same interest, $492 million, in the latest quarter as a year earlier. However, it earned substantially more on its cash and short-term investments, with the annualized rate rising to about 3.3% from 2.1%; combined with a small increase in its hoard to $111 billion, it earned $905 million in interest just in the quarter, up from $552 million.

Microsoft’s experience appears to be reflected economywide. Corporate net interest payments—that is, interest paid on debt minus that received on savings—fell as interest rates rose, the opposite of what usually happens.

The Haves and Have-Nots

There is still corporate pain from higher rates, of course, and that has created a split between the haves and have-nots in the market. The pain falls on weaker companies that were unable to lock in low rates for very long, or that chose to borrow using floating-rate bank loans or similar debt where rates rise as the Fed hikes. Companies rated as junk, the weakest category, now have the shortest-ever maturity on their debt on average, meaning they face more frequent refinancing at much higher rates. More money spent on interest means less available for shareholders, workers, and investment.

Even for weaker companies, there has been relatively little pain so far. Defaults and bankruptcies are up but far from catastrophic. Christian Stracke, president of Californian fund manager Pimco, says companies have been benefiting from higher inflation that supported profit margins, making higher rates easier to cope with. “Real [after inflation] interest rates have only recently gone positive,” he says.

The Impact on Different Company Sizes

Split the market by size and it is clear that the biggest companies are the least affected by higher rates. Calculations by Andrew Lapthorne, head of quantitative research at Société Générale, show that the interest rate being paid by the largest 10th of companies in the S&P 1500 index is barely up from its lows and still below its prepandemic peak. The rate paid by the smallest half of companies in the index has risen to the highest in more than a decade, while those in the middle are roughly back at prepandemic rates.

The Fed’s Dilemma

Policy makers who want to slow the economy face the choice between even higher rates to squeeze the vulnerable companies, or keeping rates high for long enough to start hitting companies that locked in low rates as their bonds come up for refinancing.

Impact on Consumers

Making the Fed’s job trickier still is that a similar pattern has supported consumers. Those who locked in low mortgage rates—with some securing the lowest rates ever in 2021—are, like Microsoft, paying the same on their debt while earning more on their savings. But those who didn’t qualify for standard mortgages, or who chose adjustable-rate loans, or need to borrow now, are suffering from the Fed’s rate hikes.

The Future

Of course, nothing is forever. The disparity between the winners and losers from rate increases provides yet another reason why the biggest stocks—the winners—have been by far the best performers this year. But threats to the dynamic loom: Time and the economy. The longer the Fed keeps rates high, the more bonds of even the best-quality issuers will have to be refinanced at a higher cost. And if the economy finally breaks, cyclical companies—those most sensitive to downturns, such as carmakers—faced with sharply lower cashflows will struggle to pay even low interest rates they locked in long ago.

Until then, we live in strange times. Rising rates make a big part of the economy feel richer—not poorer.

Write to James Mackintosh at [email protected]

Leave a Comment