American companies are taking enormous interest rate gambles

It is far from certain whether the Federal Reserve will increase US short-term interest rates another step next week, but the business community is already preparing for a significant drop in long-term interest rates in the coming years.

Next week it will be announced that the US policy rate has temporarily reached its peak. Because in view of the indications of declining inflation and somewhat rising unemployment, it must be very strange if the Federal Reserve chooses to raise interest rates even further. According to the so-called Fedwatch indicator of the CME exchange platform, there is even a 97% chance that interest rates will not increase. Since the beginning of 2022, the central bank has already raised the policy interest rate by 5% in eleven steps. This has made it a lot more expensive for consumers and companies to borrow money. This leaves less money for investments and expenses, so that the prices of all kinds of items rise less quickly and inflation is brought under control.

Big challenge
The major challenge for the Federal Reserve is to reduce the rate in a timely manner, so that high interest rates do not unnecessarily put a brake on economic growth. The American business community is already making an advance on this. Data collector LSEG recently announced that the maturity of new loans issued by US companies has reached the lowest level in more than a decade. This applies in particular to loans from companies in the riskier high yield segment. The average term of six years is significantly lower than the more than 7,5 years in 2022. This marks the lowest level since this type of data started being kept in 1990.

Clear signal from the business community
By opting for increasingly shorter terms, American companies are sending a clear signal: interest rates will fall again in the long term. The relatively short term gives them the opportunity to renew maturing loans at a more attractive rate. Stock market traders and economists also expect that interest rates will fall again in the not too distant future. The CME indicator suggests that there is a greater than 50% chance that the Federal Reserve will have cut interest rates by 2024 percentage point or more by the end of 1. And these types of interest rate movements can sometimes have a hard impact on the currency world.

Proportions reversed
The main reason why the dollar rose by more than 17% against the euro in the first nine months was the growing interest rate differential that arose because the Federal Reserve took action against high inflation much earlier than the European Central Bank. The ratios have now reversed and it appears that the policy interest rate in Europe will remain high for longer than in the United States. If there is no surprise move from the Federal Reserve next week and - in addition to the turnaround in the corporate loan market - there are more signals that parties are preparing for falling US interest rates, the euro could make up some ground on the dollar in the coming quarters.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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