The Upside of Lower Rates

Fed's emergency cut of 75 basis points sparks optimism about corporate reaction — and recovery.
Stephen TaubJanuary 22, 2008

Let’s face it. The Federal Reserve’s abrupt, 75-basis-point cut in short-term interest rates has sent Wall Street traders desperately scurrying to determine where the bottom is and whether to begin buying again.

But down the road, the rate cut may indeed be helping set up a recovery from what now looks and feels like a U.S. recession. The reason: Corporate America and Main Street will be quietly watching and mulling when to take advantage of this gift of lower rates, and to refinance their respective debt.

Suddenly, borrowing costs have been heavily marked down. And if the pundits are correct, next week the Fed will cut rates even further, which means short-term rates will have been slashed by more than one full percentage point in a week or so.

A 75-point reduction in financing costs — first emergency move on rates since 2001 — is enormous, and results in real savings for any company or individual who refinances debt. So look for a massive refinancing of corporate and personal debt — especially mortgages — which could jump-start the economic recovery as they work their way through the economy over the next year.

As noted last week, Standard & Poor’s estimates that $258 billion in corporate bonds could be refunded in 2008, up about 14 percent from last year, with another $249 billion to be refunded in 2009. And the trend will not be a brief one. “Refunding pressures due to maturing bonds will pick up over the next few years, with 2011 through 2014 experiencing exceptionally high volumes of maturing bonds,” said Diane Vazza, head of S & P’s Global Fixed Income Research Group.

And because of the rate cut, the resulting much-lower interest expense, compared to what companies anticipated, could be a boon — translating quickly into higher-than-expected earnings for companies doing the refunding.

Also, look for a review of their position by companies that had not planned to borrow money. With these lower rates, it now could make sense. They will then use the proceeds to either buy back their stock, raise their dividend, award a special dividend, or invest in new plants, equipment or employees.

Indeed, bank stocks rallied on Tuesday because suddenly their cost to borrow has dramatically fallen, which will enable them to lend out the money at a higher spread, helping them to firm up their balance sheets.

Individuals will similarly benefit. As rates tumble, we will no doubt see a new round of mortgage refinancings.

Afterall, members of the silent majority of the country are current on their mortgages, and not in danger of defaulting. These people will be able to lower their anticipated costs, putting more money in their own pockets. And many will spend those funds on home improvements, vacations, and other purchases that could benefit American business.

This won’t happen overnight, or even by Super Tuesday, when more than 20 states hold their presidential primary elections.

But by the third quarter, we should begin to see benefits of the rate cut, both from corporations and consumers. And then could come the next economic expansion.

This is what economic cycles have been all about for over 100 years.