Legal Alert

Fed Again Raises Interest Rates: Challenge and Opportunity Abound

September 21, 2022

Summary

As expected, the Federal Reserve today announced its fifth significant hike in interest rates this year—raising the federal funds rate by 75 basis points. With today’s increase, the Fed took its federal funds rate to a range of 3%-3.25% from near-zero levels in March. Going forward, the Fed indicated its intent to continue raising the federal funds rate until hitting a “terminal rate” of 4.6% targeted to occur in 2023, signaling significant additional rate increases to come. These actions—when combined with increased input and construction costs and mounting recession concerns—have created significant headwinds for the debt and equity markets and will surely affect how and whether new deals are structured or brought to market.

The Upshot

  • The Fed’s priority is to put “meaningful downward pressure” on inflation, getting it down to 2%, and restoring price stability.
  • Interest payments on a wide range of obligations will rise, creating funding gaps likely to stress many companies and projects, delaying or scuttling certain deals.
  • The interest rate increases are combined with the Federal Reserve’s quantitative tightening program, which is scheduled to increase to $95 billion per month in September.
  • Some U.S. banks have reportedly slowed financing and tightened borrowing terms for commercial real estate projects and other borrowers. Heightened rates also have slowed the issuance of CMBS and collateralized loan obligations.

The Bottom Line

The Fed is trying to slow the economy while avoiding a recession, hoping that its actions will lower inflation while allowing for stable demand for housing, and other select market segments. Companies would be well-served to prepare now for risk exposure and potential investment opportunities.

Ballard Spahr’s multidisciplinary Distressed Assets and Opportunities team leverages comprehensive experience in all aspects of distressed assets to help clients identify and leverage opportunities, maximize value, manage risk, and solve market-related business challenges.

As expected, the Federal Reserve today announced its fifth significant hike in interest rates this year—raising the federal funds rate by 75 basis points. With today’s increase, the Fed took its federal funds rate to a range of 3%-3.25% from near-zero levels in March. Going forward, the Fed indicated its intent to continue raising the federal funds rate until hitting a “terminal rate” of 4.6% targeted to occur in 2023, signaling significant additional rate increases to come. These actions—when combined with increased input and construction costs and mounting recession concerns—have created significant headwinds for the debt and equity markets and will surely affect how and whether new deals are structured or brought to market.

The Federal Reserve's tightening policy has resulted in significant increases to a wide range of interest rates used to set corporate and consumer borrowing rates, including commercial and residential mortgage rates. These increases have resulted in increased interest payments on a wide range of obligations, while creating capital funding gaps sure to stress many companies and projects, which could delay or even scuttle certain deals. The Fed's interest increases are combined with its quantitative tightening program which is scheduled to increase to $95 billion per month in September.

In its announcement, the Fed committee said it seeks to achieve maximum employment and inflation at the rate of two percent. In addition, the Committee said it will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in May. The Committee further said that it is “strongly committed” to returning inflation to its two percent objective.

The Committee said it will continue to monitor the implications of incoming information for the economic outlook and would be prepared to adjust the stance of monetary policy, as appropriate, if risks emerge that could impede the attainment of the two-percent goal. Its assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

So far, moves to raise interest rates from historic lows to a benchmark rate high enough to slow growth and consumer demand—and get inflation in check—have not been effective. Because rate hikes operate on a lag, the full effects won’t be felt for months. But already mortgage rates are climbing, as are the costs of consumer and commercial loans. Industry analysts have predicted that the higher borrowing costs could slow hiring and wage growth, causing economists to downgrade forecasts for growth.

In addition, American Banker today reported that some major U.S. banks have pulled back on financing for offices and other commercial real estate, issuing fewer property loans and tightening borrowing terms. The pull-back follows a surge in lending in the first half of 2022. Higher rates have slowed the issuance of commercial mortgage-backed securities and collateralized loan obligations, forcing banks to maintain more debt on their balance sheets. U.S. banks have about $2.8 trillion in exposure for non-residential property as of late June, according to the Federal Deposit Insurance Corp.

It is far from clear whether the Fed’s repeated efforts to slow the economy while avoiding a recession will be successful. Companies would be well-served to prepare for risk exposure. Questions on how to do that can be directed to the contacts listed on this alert. Ballard Spahr’s multidisciplinary Distressed Assets and Opportunities team leverages comprehensive experience in all aspects of distressed assets to help clients identify and leverage opportunities, maximize value, manage risk, and solve market-related business challenges.

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