Inflation risks and rising interest rates likely a transitory issue

Emerging from the COVID-19 pandemic, consumers with money to spend have been confronted with global supply constraints, higher prices and increasingly concerning inflationary pressures.

According to a report published in late October by the US Department of Commerce, headline inflation rose by 4.4% in September from the year before, representing the fastest such increase since January 1991. Core inflation, the preferred barometer of the US Federal Reserve, was up 3.6% over the same period.

By either indicator, inflation is running far above the Fed’s long-term 2% target. The situation may, by the end of 2021, become a little more unnerving, as the central bank’s forecasts suggest inflation could hang around the 5% mark for the rest of this year before cooling off in 2022.

The typical response from monetary policymakers would be to raise interest rates, as the IMF is advocating. For the last few years, rates have been hanging around the zero-lower bound – the Fed has not raised rates since 2018. This is important for dealmakers, as higher interest rates lead to more expensive debt financing. But there is no cause for alarm just yet, for a number of reason

First, although the IMF may be issuing warnings, it is generally aligned with the Fed’s view that inflation will cool off in 2022. This, the data suggests, is a transitory issue caused by the pandemic. Second, any rise in rates by the Fed will not come out of the blue. Under Chairman Jed Powell, the central bank has telegraphed any possible changes in policy months in advance.

Third, as supply chains recover, price increases may slow, easing some pressure. And fourth, non-traditional lenders are still likely to lend at lower rates than banks, and a great many acquirers remain cash-rich post-pandemic. More costly debt financing in the short term will not prove such a burden.

That the economy would take a hit from a global shutdown was never in doubt. But M&A activity in the Americas has bounced back with remarkable vigor, suggesting it can easily withstand a brief patch of heavy weather from higher interest rates.