As policy changes and rapid shifts in the markets continue to create uncertainty in the economic landscape, it can be difficult for businesses to make decisions about the best path forward. In a recent PNC webinar, “The New Economic Agenda and its Impact on Interest Rates and the Business Environment,” PNC Chief Economist Gus Faucher, Head of PNC Commercial Banking Mike Willetts, and Managing Director of PNC Derivative Products Group Adam Smith offered insight into the economic backdrop and strategies that businesses can consider as they navigate the ongoing volatility and uncertainty.

Economic Backdrop

Tariffs are top of mind for many business leaders, as they wait to see how, when, and where tariffs are likely to be levied and what material impacts may result. In terms of overall effects on the economy, according to Faucher, tariffs are likely to cause to a significant drag on economic growth in the short term. As tariffs lead to higher goods prices, many companies are likely to pass on as much of the increased costs to customers as they can, which is likely to put upward pressure on inflation.

However, in Faucher’s view, over time weaker GDP growth and a softening labor market will outweigh inflationary impacts, and the Federal Reserve will likely begin to cut interest rates later in 2025. If so, lower rates should help reduce borrowing costs and support stronger growth in the U.S. economy in late 2025 and 2026. But it’s important for borrowers to remember, according to Smith, that they should not assume rate cuts are imminent, given the ever-changing economic landscape and that the Fed has indicated that they will look at the totality of the data over time before supporting a rate cut.

Another component of the interest rate outlook is that long-term interest rates have moved higher due to concerns about the U.S. dollar and speculation about the nature of the country’s future participation in the global economic system. Even if there are cuts to short-term interest rates, this does not necessarily mean that long-term interest rates will fall as they react to different market factors. 

Challenges and Opportunities for Businesses

In the current environment, the best approach for businesses is to stay nimble, as the dynamic and uncertain conditions can offer both challenges and opportunities. 

  • Opportunities: According to Willetts, there are growth and expansion opportunities in the current environment, particularly in the areas of infrastructure, technology, healthcare, and advanced manufacturing. Well-positioned companies in any sector that are looking to make a strategic investment may find support for doing so, given the relatively favorable lending environment and readily available access to capital, not only from bank lenders, but also private equity and venture capital. Tariffs notwithstanding, should the current administration implement additional policies designed to support business growth and foster a steadier environment, there will likely be a surge in loan demand and an increase in capex spend and M&A. 
  • Concerns: Some of the most critical downside risks for businesses in the near term have to do with inflation and cost pressures. Passing on elevated costs on to customers may not be a sustainable strategy over a long period of time. It is important that companies look for other ways to manage costs, including streamlining operations through investing in digital transformation and automation. Many companies are also contending with a shortage of skilled workers, which may make it important to consider adjustments to employee benefit offerings and compensation. Regardless of where and how tariff impacts play out, it will be important for businesses to evaluate and potentially reengineer supply chains, perhaps particularly if the elevated tariffs on Chinese goods remain in place.

Managing Interest Rate Risk*

Amid the uncertainty, borrowers are looking for ways to deploy strategies to help manage interest rate risk and gain certainty. Smith noted that interest rate derivatives may serve as an effective tactic toward achieving this objective.

One of the major concerns many borrowers have, given the volatility, is the risk of executing a hedge and then subsequently seeing rates move against them shortly thereafter. One strategy that may be employed to counter this risk is a layering-in approach, in which the borrower can take the desired amount hedged, divide it into smaller subsets, and execute those tranches over a period of time to average into this uncertain market and smooth out some of the highs and lows. Also, the use of market orders allows borrowers to potentially benefit from intraday volatility, without requiring constant monitoring of rates.

While the building blocks of hedging strategies are mostly the same, the application of the tools can vary on a case-by-case basis. It may make sense for a borrower to only hedge part of their debt or execute a hedge for a shorter term than that of their underlying debt facility. Some companies may benefit from having floating rate debt, in which case an interest rate collar might be used to protect against a rise in rates.

When looking at pricing, Smith noted that it’s important for borrowers to keep in mind that derivative pricing reflects market expectations for rates in the future. In the current environment, the market is expecting rates to go lower, and that is accounted for in hedge pricing. In short, the prospect for lower rates in the future should not preclude the borrower from considering hedging, because those expectations are built into the hedge price.

Overall, while there are no clear paths forward through the current volatility, it’s important for businesses to focus on meeting their financial goals by taking a tactical approach and gaining certainty through interest rate hedging.

* Derivatives products are offered by PNC Bank. 

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