Middle-market firms are under financial stress as borrowing costs rise. The Federal Reserve needs to prepare for a pivot , writes Joseph Brusuelas.
About the author: Joseph Brusuelas is principal and chief economist for RSM US, an assurance, tax and consulting services firm. This publication represents the views of the author, and does not necessarily represent the views of RSM US.
Inside the real economy, firms are now facing approximately eight-percentage-point risk premiums on borrowing to meet payrolls and finance expansion. In many cases, that increase results in double-digit borrowing costs for creditworthy private firms that do not have access to the Fed’s discount window or favorable financing from large banks.Just over 35% of all firms in the middle market that need capital are turning to the shadow banking market to find financing, our survey found.
The era of zero nominal interest rates, with low or negative real rates after accounting for inflation, is over. Any loans from that period that now need to be refinanced will be much more expensive for the borrower. Depending on the balance sheet of individual firms, those rates could reach into the double digits.
This is why we think we should and will see rate cuts by no later than the second quarter of next year and a terminal rate of 3% sometime in early 2025. The three-month rate in hiring has cooled to an average gain of 150,000 a month, with unemployment averaging 3.6% over that period. We expect that hiring will continue to cool to well within the 50,000 to 100,000 level consistent with meeting demographic demand and stabilizing unemployment. That means the Fed is now well- positioned to begin addressing more pressing issues in the real economy.
The New York Federal Reserve’s multivariate core trend measures inflation’s persistence. That now sits at 2.8%, significantly lower than a year ago. As a result, we do not see a reason why the Fed needs to lift the policy rate further into restrictive terrain. Doing so would unnecessarily run the risk of causing a recession to achieve a 2% inflation target that is most likely no longer appropriate for the U.S. economy.
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