Interest Rates Continue to Influence Corporate Financing

After setting interest rates at a two-decade high last July, the Federal Reserve has held them steady for the last 10 months at 5.3%. And now everyone waiting on the central bank to cut rates should probably settle in for an even longer haul. As Jerome H. Powell, the chair of the Fed, pointed out earlier this month, inflation isn’t showing signs of abating any time soon.

For corporations looking to do some wheeling and dealing this year, monetary policy is forcing them to get creative. With cheap debt nowhere to be found, corporate mergers and acquisitions are requiring combinations of cash and equity to reach fruition.

In fact, data from financial information provider LSEG show that the volume of M&A transactions using stock or a combination of stock and cash has surged to a two-decade high since the start of 2023. Stock-only deals made up roughly a quarter of M&A volume in 2023, a share that hasn’t been seen since nearly 50% of transactions in 2001 were all stock. (The fact that this trend coincides with a two-decade high in interest rates probably isn’t a coincidence.)

It’s more difficult to discern the impact of elevated interest rates on another hot topic around Wall Street: stock buybacks. Broadly speaking, companies have eschewed repurchase programs lately. According to an estimate from Goldman Sachs, buybacks dropped 15% last year. Interest rates have undoubtedly played a part in the decline – the ability to borrow at low rates tends to make share repurchases more appealing to companies.

Now new signs are emerging that buybacks might be primed for a comeback. For instance, technology giant Apple this month announced a record buyback plan that stands to return $110 billion in cash to its shareholders. It represents the largest share repurchase program ever undertaken by a U.S. company.

What’s behind buybacks possibly coming back in fashion? Fattening bottom lines, for one thing. Strong corporate earnings mean companies need to do something with their extra revenue on hand. Investors usually appreciate it when that cash ends up back in their bank accounts.

Creeping up on the midway point of 2024, market watchers are upping their estimates of buyback activity for the entire year. For example, early in the year, Goldman Sachs projected that share buybacks would grow by 4% over the 12-month period. This month, the bank adjusted its estimated buyback volume to about $930 billion, which would represent a 13% increase from 2023. Buybacks should top $1 trillion in 2025, per Goldman Sachs’ projections.

Naturally, the Fed can’t keep interest rates this high forever. If the cost of borrowing goes down sooner than later, we could see those buyback estimates shoot up even more.

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