There is a significant danger to both our economy and our markets now, and it can be summed up in one word: “Refinancing.” The Fed has raised interest rates to such a level in their fight with inflation that there is a massive amount of collateral damage coming for companies that need to roll over their debt, as the hit to both revenues and profits could be significant. I point this out on Labor Day because there will be a lot of labor required to control the refinancing costs, especially at a time when the American banks are significantly tightening their lending criteria as mandated by the Fed.
Federal Reserve Bank of Atlanta President Raphael Bostic said the U.S. economy faces a period of some disruption as debts are refinanced at significantly higher interest rates, putting some pressure on both financial institutions and the government. “We have a lot of existing debt out there that is at very low prices,” Bostic stated. “When that comes due, they’re not going to be able to refinance into comparable prices. There’s going to be an adjustment that needs to happen on that. So, I actually think there’s a shaking out that’s about to happen at all levels.” My view of Mr. Bostic’s comments is that he is spot on.
About a quarter of US investment-grade debt is maturing from 2023 to 2025, according to Fidelity. They went on to state that “companies had borrowed cheaply before this current rate hike cycle, but they could face far higher refinancing costs after maturity due to rising interest rates. Corporate debt is typically refinanced rather than paid off.” Bloomberg states that, “Borrowers are not feeling the full pressure of the interest rate because they are sitting on locked rates which is not a permanent phenomenon. A company which financed itself at 2%, 3%, 4% is going to be financing at 10%, 11%, 12% now. That’s a huge shock.”
Kiplinger’s view is that the economy is set to grow more slowly in 2024. Their opinion is that we will see a 1.1% GDP growth in 2024 versus 2.3% GDP growth in 2023. All of this is also going to have a significant impact on the American government. From August 2022 to this July, the federal government spent roughly $6.7 trillion while bringing in roughly $4.5 trillion. That represents a total increase in spending of 16% relative to last year and a 7% decrease in revenue, according to the Committee for a Responsible Federal Budget.
Overlaying all of this is the United States itself. Our Gross Domestic Product (GDP) is now $10 trillion less than our national debt. This will also impact corporate earnings, profits, and debt as the country lurches into a very bad place. It is not only the Fed that is causing issues but the Congress which is acting in a very irresponsible manner, in my opinion. This may even cause a decline in our currency as the rest of the world begins to take notice of America’s precarious financial position. If the Congress does not lower our spending and if the Fed keeps raising rates, then I fear we may have a severe national problem that will not only affect corporations but people, as they cannot deal with ever-rising borrowing costs.
Inflation is an issue, no question about it, but it is not the only issue. In fact, the cost of money may become more important than our inflation rates. The collateral damage may turn out to be more significant than the inflation damage, when all is said and done.
All of this is also likely to have a negative effect on both our bond and equity markets and so, once again, I advise caution when investing your money now. This is also the reason that I like income products, because if your income is higher than our borrowing costs, then you are winning in the “Great Game.”
“Everyone has a will to win but very few people have the will to prepare to win.”
– Vince Lombardi
Don’t let the “Great Game” eat you. You must eat the “Great Game!”
Original Source: Author
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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