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Will Fed Rate Cuts Reignite the M&A Market?

Despite underlying demographic trends that suggest potential growth, various factors have suppressed activity in recent years.

A critical focal point is whether the Federal Reserve’s decision to cut interest rates could serve as the catalyst needed to reinvigorate M&A transactions.

Reasoning Behind the Prolonged Downturn in M&A Activity

The current downcycle in the M&A market is not only protracted but also deviates from historical patterns. Traditionally, M&A correction periods span 12 to 18 months, with cycles shortening as information becomes more accessible and markets become more efficient. However, the present downturn has extended beyond this typical timeframe.

One primary reason for this anomaly is the unprecedented peak in M&A activity witnessed in 2021.

As the global economy began recovering from the COVID-19 pandemic, there was a surge in deal-making driven by the clearance of backlogged transactions that had been postponed during the crisis. This increase created an artificial high, making subsequent years appear sluggish by comparison.

As we approach the end of 2024, projections indicate that M&A activity will not rebound sufficiently in the fourth quarter to offset the downturn experienced over the past two years. Compared to the peak levels of 2021, there is even an anticipated decline of approximately 39% in deal volume, a significant drop that underscores the depth of the current downcycle.

Despite the bleak statistics, the foundational demographics that drive M&A activity remain favourable.

“Interest rate cuts could be the spark the M&A market needs. By reducing borrowing costs, companies are better positioned to pursue transformative deals that align with their long-term strategic goals.” — said Gabriel Hansen, Associate at MDN Group

Factors such as ageing business owners looking to exit, abundant capital reserves held by private equity firms, and strategic imperatives among corporations suggest that the market is poised for a rebound. The extended lull has many experts believing that a recovery is not only possible but also overdue.

Interest Rate Cuts as a Catalyst for Deal-Making

The Federal Reserve’s monetary policy plays a pivotal role in shaping the economic environment in which M&A transactions occur. Recently, the Fed has initiated a cycle of interest rate cuts, which could have profound implications for deal-making activity.

Lower interest rates reduce the cost of borrowing, making it more attractive for companies to finance acquisitions. This reduction in the cost of capital can lead to better valuations and more favourable deal structures. Moreover, interest rate cuts can alleviate one of the most significant barriers to M&A activity: uncertainty.

Market participants can model and plan for scenarios involving rising or falling interest rates. However, when the direction of monetary policy is uncertain, it challenges forecasting future costs and returns, causing many potential deal-makers to adopt a wait-and-see approach. By establishing a more evident trajectory for interest rates, the Fed’s actions may encourage investors and companies to move off the sidelines.

Additionally, lower interest rates can shift the focus from defensive or incremental acquisitions to more strategic and transformative deals. Companies may pursue platform acquisitions that can significantly alter their market position rather than merely adding complementary businesses or products.

Influence of CEO Confidence and Regulation on M&A Recovery

Beyond monetary policy, CEO confidence is a critical determinant of M&A activity.

The sentiment among business leaders affects their willingness to engage in significant transactions. Currently, CEO confidence levels have diminished considerably from their highs in 2021. During that peak period, confidence levels were around 81%, near an all-time high. In contrast, recent figures place confidence in the high 30s to low 40s.

This decline in confidence correlates strongly with the Federal Reserve’s interest rate policies. Historically, when interest rates fall below 2%, CEO confidence tends to rise. Increased confidence leads to a greater supply of companies willing to enter the M&A market, providing more opportunities for deals.

“While regulatory pressures and CEO confidence remain hurdles, the underlying fundamentals for M&A growth — capital availability and strategic imperatives — are still robust. The current lull is likely the calm before a wave of renewed activity.” — said Peter Hubert, Partner at MDN Group

Regulatory considerations also weigh heavily on M&A decisions. The current regulatory environment, particularly actions by the Federal Trade Commission (FTC) under key leadership figures, has introduced additional complexities. Stricter scrutiny and potential challenges to large mergers can deter companies from pursuing significant acquisitions.

High-profile regulatory cases, such as ongoing discussions involving major technology firms, can influence market sentiment. While some believe that changes in political leadership could alter the regulatory landscape, the consensus is that regulatory pressures will continue to impact large-scale M&A transactions regardless of the administration in power.

Moreover, many CEOs may misinterpret the broader market conditions based on headlines and public market performance. Negative news and volatile stock markets can create a perception that the environment is not conducive to deal-making, causing some leaders to hesitate.

However, for high-quality companies, there remains a supply-demand imbalance that can lead to robust valuations, sometimes exceeding those seen during the market peak in 2021.

Conclusion

In summary, while the M&A market has been mired in an extended downturn, several indicators suggest that a recovery may be imminent. The Federal Reserve’s interest rate cuts have the potential to stimulate activity by reducing borrowing costs and providing clearer market visibility. CEO confidence and regulatory factors will also play significant roles in determining the pace and extent of the recovery.

As business leaders gain more confidence in the economic outlook and navigate the regulatory landscape, the fundamental drivers of M&A activity — such as strategic growth objectives and the availability of capital — could lead to a resurgence in deal-making.

The convergence of these factors may soon uncork the bottleneck that has constrained the M&A market, bringing in a new phase of strategic transactions and market consolidation.