Extended periods of high interest rates often benefit larger corporations more than smaller ones in various aspects.

The era of historically low interest rates has passed, and the Federal Reserve may initiate a gradual reduction of its key interest rate, which currently stands at a 23-year high, later this year. Contrary to market expectations of an aggressive approach, the Fed might opt for a more restrained strategy. While high interest rates pose challenges to companies across the board, smaller firms are particularly vulnerable compared to their larger counterparts, which possess greater resilience and resources to withstand economic pressures.

This shift marks a significant departure from the near-zero interest rates implemented during the early stages of the Covid-19 pandemic. At that time, the Fed aggressively cut rates to stimulate a struggling economy grappling with soaring unemployment and reduced consumer spending. Prior to the pandemic, the Fed had not raised its key interest rate above 3.25% since 2009. Currently ranging between 5.25% and 5.5%, these rates reflect a departure from the era of “easy money,” characterized by accessible credit for consumers and businesses.

Despite a notable slowdown in inflation from its peak in the summer of 2022 and the absence of significant economic deterioration, the Fed lacks immediate incentives to slash rates, at least not as early as March or to near-zero levels.

The Fed’s mandate includes stabilizing prices and maximizing employment, prompting rate reductions during periods of rising unemployment or when the rate of inflation falls below the central bank’s 2% target.

Lauren Goodwin, economist and chief market strategist at New York Life Investments, provided insights into the implications of prolonged high interest rates, particularly for businesses, in an interview with Before the Bell, which has been edited for brevity and clarity.

Before the Bell: How do higher-for-longer interest rates impact companies of different sizes?

Lauren Goodwin: Challenging economic conditions often favor larger companies due to their greater financial reserves, capital stock, and regulatory protections, enabling them to weather storms more effectively. Consequently, investors are increasingly gravitating towards large-cap stocks in the later stages of the economic cycle. Conversely, smaller companies typically thrive in periods of accelerated economic growth characterized by a risk-on environment, but struggle amidst investor uncertainty.

What are the implications of higher-for-longer rates on mergers and acquisitions (M&A)?

Goodwin: While the notion of larger companies acquiring smaller ones may hold true in a high-rate environment, it’s essential to recognize that elevated interest rates, coupled with slowing economic growth or declining revenue, pose challenges for all businesses, including those engaged in M&A activities. Although M&A activity has been subdued in the past year due to high interest rates, suggesting that such conditions might deter companies from engaging in mergers or acquisitions, struggling businesses may become attractive targets.

What is the outlook for M&A activity given the Fed’s potentially less aggressive rate cuts?

Goodwin: Despite market expectations of three interest-rate cuts totaling 75 basis points this year, indicative of a similar environment for M&A activities, there remains a possibility of further rate cuts if economic activity decelerates more than anticipated. However, this scenario presents a dichotomy for the M&A environment. While lower interest rates may reduce the cost of capital and stimulate M&A activity, sluggish economic growth could lead to reduced revenue for many companies.

Gas Prices on the Rise: Gasoline prices are rapidly increasing nationwide, with the national average jumping 11 cents in the past week alone to $3.28 per gallon, as reported by AAA. This surge, the highest in nearly three months, coincides with increased demand as winter wanes and the need for more expensive summer fuel arises.

Refinery outages, including a prolonged shutdown of the largest Midwest refinery, further constrain gas supply, exacerbating the price hike. Rising gas prices compound the financial strain on consumers already grappling with high living costs. Additionally, these developments pose challenges for policymakers in Washington, complicating the Federal Reserve’s efforts to combat inflation and undermining the administration’s messaging on economic progress. As gas prices continue to escalate, the impact on consumers intensifies, presenting a sensitive issue with implications beyond mere market dynamics.