US Economy Faces 'Reckoning' as Loan Costs Soar

The era of easy money is finally coming to an end, and the U.S. economy faces a 'reckoning' as businesses grapple with rising loan costs, according to a new survey from RSM.

The survey findings reveal that commercial and industrial loans have become more expensive due to rising interest rates, making it challenging for middle-market firms to meet payroll and fund expansion.

A significant majority of senior executives, approximately 77%, anticipate further interest rate hikes in the near future. Moreover, an astonishing 82% of respondents in the RSM Middle Market Business Index survey expressed concerns that rising rates could negatively impact their operations.

'The result is a risk to economic growth across the real economy and, potentially, a recession,' warns RSM chief economist Joe Brusuelas in a related blog post about the survey.

Smaller businesses are feeling the brunt of the astronomical rise in rates. According to the survey, small and mid-sized firms now face financing costs between 10.9% and 15.5%, significantly higher than in the past two decades.

For many firms, higher rates have yet to take effect. Currently, approximately one-third of smaller middle-market firms have loans with interest rates below 5%, while 24% have loans between 5% and 7%. However, these loans will eventually need to be rolled over at higher rates, posing a further threat to cash flow.

Research indicates that after a tightening shock of 100 basis points, research and development spending declines by 1% to 3%, while venture capital spending plummets by about 25% in the following one to three years, points out economist Joe Brusuelas.

In the past year alone, Federal Reserve policymakers have sharply raised interest rates, approving 11 rate hikes to combat inflation. Interest rates have surged from near zero to over 5%, marking the fastest pace of tightening since the 1980s.

While additional rate hikes are on the table, the Federal Reserve will hold rates steady at the current 22-year high during their upcoming meeting in September.

The rapid rise in interest rates is having a profound impact on lending conditions across the economy, affecting sectors such as manufacturing, housing, technology, life sciences, and private equity. These industries will face significant adjustment periods during this new age of high interest rates.

According to Brusuelas, 'The zero interest rate era has ended. A new era with higher nominal and real interest rates is upon us.' He also highlights the risk posed by a large volume of loans made during the previous era that will need to be rolled over at significantly higher rates.

This evolving economic landscape demands attention and strategic action from businesses and policymakers alike. As loan costs continue to rise, the pressure intensifies on the U.S. economy to navigate this period of uncertainty while mitigating the risk of a potential recession.