Does Federal Reserve Policy Affect Private Equity Employment?

The Federal Reserve officially announced the end of quantitative easing at its October 2014 meeting.  The announcement of the end of quantitative easing (known as QE) presents private equity professionals with the question: How will an increase in the Federal Funds rate affect private equity employment?  Does what the Fed do affect the private equity industry at all?

Private Equity Employment Over the Past 25 Years

Since 1990, the private equity industry has been through three recessions and two booms. The first recession occurred in 1994 to 1995, with private equity employment dropping slightly from 22,160 (July 1994) to 21,900 (April 1995). The second recession came after a peak employment of about 34,000 in March 2001.  The technology-bust recession saw employment decline by 30,000 in October 2003, a decline of almost 12%. The third recession came after a peak in the  private equity industry employment of around 36,000 in August 2008.  The decline amounted to about 3,000, with private equity employment reaching a trough in May 2010 at about 33,000, representing an overall drop of around 8%.

Switching to the booms, the two private equity booms can be classified into a big boom period and a little boom period – the boom from April 1995 to March 2001 and the shorter expansion from October 2003 to August 2008. As shown, the boom from April 1995 to March 2001 saw employment jump by about 12,000, growing by about 54%. The boom from October 2003 to August 2008 saw employment jump by around 5,500, an increase of about 18%.

The next part of the equation is the Federal Funds target rate.  The following graphic reflects the Federal Funds rate from 1990 to October 2014. Over the past 25 years, the Federal Reserve has had three “long” loosening cycles (a loosening cycle is when the Fed is lowering the Federal Funds target interest rate). The first was from June 1990 to December 1993, with the Fed rate dropping from just over 8% to a little under 3%. The second long loosening cycle occurred from December 2000 to May 2004.  Over this period, the Fed rate dropped from about 6.5% down to a little over 1%. The third loosening cycle occurred started in July 2007.  This loosening cycle is still ongoing, with the target Fed rate virtually zero (0 to 0.25%).

The Federal Reserve has also gone through three “long” tightening cycles (although the tightening cycles are generally much shorter than the loosening cycles). The first was from December 1993 to April 1995, with the rate going from around 3% to 6%. The second tightening cycle occurred from January 1999 to July 2000, with the rate increasing from around 4.5% to about 6.5%. The third tightening cycle happened during the housing market boom, with the rate rising from a low of 1% in May 2004 to a high of 5.25% in August 2006.

With the two components of the question established, the following is what the two measures look like when overlaid.

The two are closely related.  A decrease in the Federal Funds rate is generally associated with poor or decelerating economic conditions.  Unsurprisingly, when economic conditions are worsening, or just in general not good, private equity employment generally declines.

How strong is the correlation and what’s the magnitude of the correlation?  Without going too much into econometrics, the linear relationship comes out at -1.5. Presuming that the simple linear relationship were correct, the -1.5 means that if the Federal Funds rate jumped from the current approximately 0% to 1%, private equity employment may drop by 1,500 individuals. (More detailed econometrics confirm a negative effect, but with a smaller magnitude.)

Overall, the Federal Reserve may start a new tightening cycle after almost 10 years of a quite loose monetary policy.  The increases may, over some time, put downward pressure on private equity employment.