Looking at Private Equity Deals by Federal Reserve Tightening Cycle

Unless the American economy completely unleashes in the next couple of months, the Federal Reserve is likely to raise the federal funds target rate sometime this year. The pending rate hike, at least if you believe indications from executives of the U.S. central bank, poses the question: what might a Fed rate hike mean for private equity deals in the coming year?

Looking at the Empirics

Of the many methods one could use to address the issue, one method is to see what the historical connection has been. The following graphic is such a look.

On the vertical axis is the percentage gain or decline in private equity deals since the start of the given tightening cycle. On the horizontal axis is the number of days the given cycle lasted. Each colored line represents a given Fed tightening cycle. The label on each line represents the month and year in which the Fed first started raising rates.

Discussion of the Empirics

Interestingly, Fed rate hike “seasons” are generally correlated with reasonably good private equity deal volume, as well as average deal value. The first graphic that follows is the percentage change in deal volume; the second is average deal value.

Overall, during the typical Federal Reserve tightening cycle, the average deal volume grows about 18%, while the median length of a Fed tightening cycle is 229 days.

There is, of course, a wide range of outcomes during Fed tightening cycles. Deals performed well during the tightening cycle that began in June 2004, whereas deals dropped more than 15% during the the tightening cycle that began in March 1988.

What Does This Mean?

What does performance of private equity deals and value mean for the industry during the pending Federal Reserve tightening cycle? Essentially, there’s a positive bias to the data, meaning that a Fed rate hike will probably be correlated with continued strength in the private equity industry.  Of course, there’s also the change, albeit of a lesser probability, that deals will be affected the Fed rate hike.

CONCLUSION

If things according to what Ms. Yellen and other Federal Reserve executives have indicated, the Federal Reserve is soon to raise the federal funds target rate. Should the Fed take this step, it would be the first time in eight years that Federal Reserve bankers have considered any monetary tightening.

In looking at the performance of private equity deals by Federal Reserve tightening cycles, private equity deals generally continue on a strong path during Fed tightening cycles.  Unsurprisingly, any potential weakness in private equity deals occurs towards the end of Federal Reserve tightening cycles.