What The Fed Interest Rate Cut Means for M&A

Published on 9/19/2024

Throughout 2022 and 2023, the Fed repeatedly raised the federal funds rate. The FOMC faced little choice but to battle rapidly rising inflation, but there have been consequences. (Some may argue these were intended consequences.)

Expensive debt has exerted downward pressure on M&A activity. This has affected both entrepreneurs taking companies to market and buyers looking to finance acquisitions with debt capital.

The state of M&A

Over the past 12 months or more, many would-be sellers have lingered on the sidelines, waiting for higher valuations—closer to the 2021–2022 peaks—to return. Buyers, for their part, have been reluctant to look beyond the highest quality deals and have been putting even those companies through the wringer with rigorous due diligence and an acute focus on financial performance.

In our experience, most deals in recent months have been “priced to perfection.” Buyers have offered little latitude for missed performance targets. If there is any sign of hope, it has been somewhat greater willingness among buyers of late to renegotiate pricing and terms, rather than simply walking away from diligence issues or off-plan financial results.

If 2021 and 2022 represented a time when buyers looked for any reason to do a deal, the last 12 to 18 months represented a period when buyers looked for any reason not to do the deal (or at least, not to do the deal at the original terms).

Between lower M&A volume and all-too-common busted deals, private equity firms are currently sitting on more than $2 trillion in dry powder. They can, and in fact they must, eventually commit these funds to transactions. The question is, when?

Fed-centric frustration finally relieved?

Market watchers have long been predicting that the Federal Reserve would take steps to ease borrowing costs. Nonetheless, the Fed held steady into Q3.

July was the latest Fed meeting to come and go with no action. This was a bridge too far for some commentators who had hoped for at least a 25 basis-point reduction to facilitate an economic “soft landing.” The weakening labor market that soon followed made a September rate cut all but certain in many minds, especially as inflation finally approaches the Fed’s 2% target. Indeed, Fed chair Jerome Powell said in August, “The time has come for policy to adjust.”

Now it’s happened. Yesterday the Fed announced a cut of 50 basis points to the target federal funds rate. So, what does this mean for M&A?

Reading the rate cut tea leaves

Let’s be clear: there is widespread celebration that the Fed is loosening its grip a bit. Importantly, this cut is more significant than the 25 basis-point reduction anticipated by 90% of economists Reuters surveyed. The extra 25 points may augment overall impact. 

Although the adjustment could boost M&A activity to some degree, it’s too soon to expect a massive and immediate rebound.

The fact is that 50 basis points isn’t a huge reduction to a rate that was hovering above 5.25%. Moreover, many lenders already built in at least a 0.25% cut, so borrowing costs may not be noticeably affected. And with more cuts likely on the horizon, some prospective borrowers could hold out awhile before reengaging.

All told, whatever increase we see in private lending is unlikely to be enough to dramatically reshape the M&A market yet. That will probably take further cautious reductions, but yesterday’s result still marks a favorable first step.

What’s next?

Now all eyes turn to the Fed’s next meetings in November and December. It’s too early to say, but many experts consider cuts of 25 basis points most likely going forward.

That means we could be in for a slow march back to a more balanced or even seller-friendly market. We’ll keep you updated as we see additional data and have insights from the market landscape.