The interest rate environment has acted as a major market force for much of the past few years, and that doesn’t seem likely to change anytime soon.
The U.S. Federal Reserve began raising its benchmark federal funds rate in March 2022. Inflation was soaring and the central bank sought to create a more restrictive borrowing environment in order to cool down the economy and slow the rate at which it inflated. The Fed hiked interest rates to a multi-decade high of 5.25% to 5.5% and has since lowered its target range by just 100 basis points to 4.25% to 4.5%.
In the nearly three years since the Fed kicked off its current interest rate cycle, investors have responded to its every move. And the cycle is far from over. Central bankers have signaled that they don’t plan to cut rates any further until they see convincing evidence that inflation is cooling sustainably. Until that day comes, savvy investors will continue to keep a close eye on the Fed’s interest rate moves — and their effects on the secondary markets.
It’s relatively easy to predict how the public secondary market will react to the Fed’s shifting stances on interest rate policy.
In recent years, investors have typically reacted negatively to signs that the Fed will keep rates higher for longer, such as hawkish comments from Federal Reserve members, hotter-than-expected inflation data, or even reports showing positive labor market or GDP growth. Those tend to give the central bank confidence that its policy is not having a crippling effect on the broader market.
On the flip side, the market has historically responded positively to Fed rate cuts, or even hints that it might lower interest rates. This is because a less restrictive borrowing environment is usually perceived as good for businesses, small and large.
The effect that the Federal Reserve’s interest rate policy has on private secondary markets is less cut-and-dry.
Shares of privately held companies are not traded on public exchanges like the Nasdaq or NYSE. Given their smaller pool of shareholders, and the larger breadth of knowledge they typically have, the valuation of private companies tends to be less responsive to changes in monetary policy.
Those opportunities aren't just for private equity firms anymore. Platforms like Augment Capital* now provide accredited investors access to pre-IPO company shares. While privately held companies may respond differently to market forces than public ones, investors now have more options to participate in these markets.
However, some private fund managers have noted that the interest rate environment of recent years has led to a starker divide between well-run and poorly managed private companies.
According to a December report by the CFA Institute, a low-rate environment allows “bad” companies to borrow cheaply and stay afloat for longer. But with rates high, these companies are more likely to fail, while “good” companies are able to operate even in a restrictive climate.
No one can say for certain what the Fed’s next move will be, or how the market will respond. However, recent remarks from Chairman Jerome Powell and other Fed officials seem to suggest that the central bank won’t resume cuts in the near future.
The latest batch of inflation prints has shown persistent price growth. And the vast majority of market observers predict the Fed will hold rates steady at its March meeting, per CME Group’s FedWatch tool.
If the CFA Institute’s analysis is to be believed, a higher-for-longer policy potentially means more short opportunities for private companies with ultra-high valuations and lackluster fundamentals. And it also makes it more important than ever to assess the leadership and culture of a privately held business before investing in it long-term. Meanwhile, if the Fed does resume rate cuts, it might make riskier bets on disruptive private companies in the pre-IPO shares space a little more enticing.
*Securities transactions are executed on Augment Capital, LLC's ATS and offered through Augment Capital, LLC (member FINRA/SIPC).
Important Disclosures: Investing in private securities involves substantial risk, including the potential loss of principal. Private securities are typically illiquid, have limited pricing transparency, and often require longer holding periods. These investments are available exclusively to qualified accredited investors and offer no guarantee of returns. Additionally, past performance of private securities does not indicate or predict future results.