KCSA Strategic Communications : Fed Rate Hike and Your IPO

Posted by Alisson Soss on January 22nd, 2016

Fed Rate Hike and Your IPO

How long did we wait for a rate hike?

Wednesday, December 16, the Federal Open Market Committee (FOMC) announced that the target range of the benchmark federal funds rate will be raised, from 0% to 0.25%, to 0.25% to 0.5%, effective on December 17, 2015. The unanimous vote marks the first U.S. rate hike in over nine years.

Did they have a choice?

While the December vote was unanimous (in a nod to the leadership of FOMC's Chairwoman Janet L. Yellen), the opinions of members of the FOMC were, in actuality, split: some voicing that they thought the move was months late, others asserting that a further delay in a rate hike would be prudent. Yellen arguably didn't have a choice, having told the world over and over the rate hike was coming. The modest 0.25% rate increase did work to back Yellen out of the proverbial corner - the Fed dialogue could now shift to how rates may gradually rise over the next 12-18 months (gradually underscoring the ample breathing room allowed for the pace of the rate increase based on future incoming economic data); any further delay may have called into question Yellen's analysis of the situation and her repeated pronouncements that continued improvements in the labor markets and economy warranted such action.

Was the move too early?

After the announcement, stock markets around the world rallied - an initial confirmation that Yellen got it right. However, in the weeks following the rate hike, market turbulence has renewed worries about global economic growth and further underlined the concern that the rate hike may, in fact, have been effectuated too soon.

Measured against the Fed's dual mandate to foster full employment and price stability, some who oppose the rate hike point to the fact that we are still millions of jobs away from full employment (the Fed sees a long-run unemployment rate at 5-5.2%, which is not far from today's rate of 5.5%) and that inflation forecasts remain below the Fed's target of 2% (the Fed's actual forecast for 2016 is for an inflation rate of 1.7-1.9%).

To justify the timing of the rate hike, Yellen referenced the known lag in the impact of policy actions and her sense that the US economy has truly turned a corner with little at risk from a 0.25% rate hike:

'The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.'

What is the road ahead?

The current (tentative) plan provides for additional gradual rate hikes to a targeted federal funds rate of 1.375% by the end of 2016 - of course, as Yellen admits, the timing is far from certain:

'This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.'

Still, one immediate certainty is that of a higher cost of capital.

Will it affect fundraising?

Hopefully, start-ups have been prudent and have already locked in funding for the next couple years. For those that have not, there is even more uncertainty ahead - as credit markets now inevitably tighten, I predict that there will be an even greater scrutiny of companies to fund and that the funding will be done at a higher expected cost.

At the same time, Unicorns, private companies with valuations in excess of $1 billion, may be forced to do an initial public offering (IPO) in order to fund future growth. For the past 9 years, low interest rates have enabled these companies to inexpensively borrow and raise funds from institutions willing to take on more risk in return for yields greater than what has been available in the fixed-income markets. However, a continued rise in the federal rates will likely decrease the amount of investment funds previously available to unicorns by instead increasing the yields and hence attractiveness of alternative government and corporate bond issues; this comes when private investors were already expected to push Unicorns toward an IPO in hopes of exiting at last year's aggressive valuations.

With the trend toward tighter credit market conditions and a pessimistic global equity outlook for 2016, both the capital markets and private companies face a difficult funding transition ahead.

References:

Federal Reserve, 2015 Monetary Policy Releases, December 16, 2015: http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm

Ibid

David Gilbert, Fed Rate Hike May Force Unicorns Like Uber, Airbnb And Snapchat To IPO In 2016, Risking New Market Bubble, December 17, 2015: http://www.ibtimes.com/fed-rate-hike-may-force-unicorns-uber-airbnb-snapchat-ipo-2016-risking-new-market-2229868