Higher-for-longer interest rates favor large companies over their smaller rivals in many ways

The days of ultra-low interest rates are long gone, and the Federal Reserve could begin paring back its key interest rate from a 23-year high later and less aggressively this year than markets expect. High interest rates squeeze companies of all sizes, but that’s especially the case for smaller firms, unlike large companies better equipped to weather the storm.

It’s a vastly different reality from when rates were near zero in the early days of the Covid-19 pandemic, when the Fed cut aggressively to stimulate a battered economy dealing with high unemployment and a sudden pullback in spending. Before the pandemic, the Fed’s key interest rate had not gone above 3.25% since 2009. It’s currently at a range of 5.25-5.5%.

That was an era of ’easy money,’ since it wasn’t so costly for consumers and businesses to access credit. Since inflation has slowed markedly from its four-decade peak in the summer of 2022 without the economy deteriorating, at least for now, the Fed doesn’t have any incentive to cut rates as soon as March or to bring them near zero.

The Fed is responsible for stabilizing prices and maximizing employment, and it reduces interest rates when unemployment is rising or when the rate of price increases slips below the central bank’s 2% goal.

More challenging economic environments tend to favor larger companies on most levels. They tend to have more buffer, a larger capital stock, and bigger reserves. Small companies tend to perform best when economic growth is accelerating because there’s more of a risk-on environment writ large and tend to struggle when investors are more uncertain.

The premise that there might be opportunities for larger companies to acquire smaller companies stands to reason, but a higher rate environment, especially if economic growth or top-line revenue is slowing, is challenging for everybody, including the capital markets. M&A activity has been slower in the last year as a result.

The market is pricing in three interest-rate cuts this year of 25 basis points each. Cutting interest rates by 75 basis points over the course of this year is still restrictive policy, so it will still be a similar environment for mergers and acquisitions specifically. If economic activity slows more than expected, there’s a reasonable likelihood that the Fed ends up cutting quite a bit more this year.

Gasoline prices are moving swiftly higher across the country, with the national average climbing 11 cents in the past week alone. This increase is due to a combination of normal factors such as the approaching end of winter and refinery outages, including a shutdown of the largest refinery in the Midwest. Rising gas prices are bad news for consumers already frustrated by the cost of living. Additionally, higher gas prices complicate the Federal Reserve’s war on inflation and may undermine the White House’s election year message.

Next week’s highlights include earnings releases from HSBC, Walmart, Home Depot, Barclays, Caesars Entertainment, Dillard’s, Nvidia, Rivian, Fidelity, Marathon, Etsy, Wingstop, Marriott, Intuit, Pacific Gas & Electric, Live Nation, Wayfair, Warner Bros. Discovery, and Icahn Enterprises. The Federal Reserve will also release minutes from its policymaking meeting in January, and several Fed officials will deliver remarks. Other economic reports scheduled for release include the S&P Global February business surveys, the Chicago Fed’s National Activity Index for January, the US Labor Department’s jobless benefits report, and the National Association of Realtors’ existing-home sales report for January.