Fed Policy Warrants a Change in the Way Companies Message to Investors

Written By Victoria Sivrais, Partner & Chris Odeh, Senior Director & Steve Adams, Managing Director

April 7, 2022

The Fed can pull many strings.

The U.S. Federal Reserve monitors and guides the growth rate of the economy. It has a dual mandate: to keep prices steady and to keep unemployment low. To achieve both objectives, the Fed works to strike the right economic balance by adjusting the amount of money in the economy relative to output, primarily by manipulating interest rates. The Fed lowers the rates when the economy needs a boost. Then, when price inflation soars too high, the Fed can raise interest rates and increase borrowing costs to slow the economy to bring prices back to a healthy level.

But things don’t always go exactly as planned. For years, despite near-zero interest rates, policy tools like quantitative easing, and record-low unemployment rates, inflation was below the Fed’s target—inexplicably low in many stakeholders’ opinions.

Forces like a global pandemic clearly have tremendous sway too.

With the onset of the COVID-19 pandemic, a storm of inflationary pressures hit the economy all at once, causing some of the most extraordinary price increases in U.S. history. Recent key pressures driving the current inflation rates include:

  1. Waning availability of many goods caused by business lockdowns and closures  
  2. Increasing product prices resulting from the demand for goods significantly outpacing the demand for services
  3. Productivity shortages due to the inability to re-hire laid off employees quickly enough (or at all) when lockdowns ended and service demand returned
  4. Restricted available talent pool due to health concerns, further exacerbating staffing challenges
  5. A devalued dollar triggered by the massive federal stimulus, further driving price increases

Today, these pressures are compounded by skyrocketing commodity and energy prices in the wake of Russia’s invasion of Ukraine. Some of the current drivers of inflation, such as heightened consumer demand, will eventually resolve themselves. Others, like the increased money supply due to stimulus, will not abate without further intervention by the Fed.

The Fed is already pushing back.

The Fed has kept cheap capital flowing for over a decade with extraordinarily accommodative monetary policy, but this strategy is quickly coming to an end. After a preliminary increase of 0.25% in March, many investors are anticipating that the Fed will increase the Overnight Federal Funds Rate by 0.5%, marking the first rate increase of this magnitude since 2000.

As prices and earnings reach record highs, many are expecting consecutive 0.5% rate increases at the following meetings this year. Other interest rates (e.g., mortgages, business loans, credit cards, and savings accounts) will ultimately follow suit, making it more costly to borrow and more lucrative to save.

And we should expect even more federal action to come.

Look for the Fed to shrink its balance sheet soon. It can accomplish this by either selling Fed-owned assets or choosing not to reinvest in maturing securities. Either tactic will reduce overall liquidity available for consumers and businesses, further slowing economic activity.

Plan your organization’s response.

Higher interest rates will increase the cost of capital for both consumers and businesses. Consumer demand will decrease as debt becomes more expensive and saving is increasingly rewarded. Business growth will slow in response to suppressed demand. Furthermore, as bonds become increasingly attractive investments when compared to equities, companies may begin taking a different approach to raising capital.

For investor relations officers and CFOs, all of this translates into four key takeaways:  

  1. Buybacks and dividends may lose favor. As the cost of carrying debt increases, many companies will move quickly to reduce liabilities. This could impact avenues for returning capital to shareholders, such as buybacks and dividends.
  2. Companies will retain more dry powder. With potentially less pressure to deploy excess capital immediately, more companies may elect to keep liquid capital on their balance sheets.
  3. There will be an asset allocation out of stocks and into bonds. Institutional investor activity in equities will likely decrease as more firms shift assets toward fixed income investments. This may lead more companies to issue corporate debt as a way of raising capital.
  4. Valuations, all things being equal, will decrease. As the economy slows, inflated corporate valuations will adjust accordingly. This could potentially lead to enhanced M&A activity as buyers take advantage of good-value deals.

With growth slowing, your qualitative investment narrative and roadmap to revenue and cash flow growth become even more important.

In each of these circumstances, investor relations teams will be on the hook to tell a new or tailored story to the investment community. In periods of growth, you can often rely on the numbers to speak for themselves. But when the numbers trend down, the relative importance of your company’s qualitative message trends up.

If you’d like support in developing a high-quality message for investors and an effective engagement plan to address current macroeconomic factors, give us a call. We can help make sure every aspect of your story and investor relations strategy is right for right now.

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