Lower Rates Could Drive Increased M&A Activity in the Coming Quarters

Lower interest rates could trigger a significant increase in mergers and acquisitions (M&A) activity in the coming quarters, according to strategists at Wells Fargo in a recent report.

The investment bank points out that while M&A activity is currently below long-term averages, there has been a modest improvement from the lows observed earlier in 2023. This recovery is partly due to growing confidence that the Federal Reserve might successfully navigate the economy towards a softer landing.

Moreover, the increasing likelihood of interest rate cuts beginning in late 2024 and extending into 2025 has sparked optimism among investors regarding a potential rise in deal activity, as financing conditions are expected to become more favorable.

Typically, in most mergers, the acquiring company offers a premium over the target company’s existing stock price. Although the majority of the price difference between the offering price and the current price tends to close quickly after the announcement, a portion of the premium usually remains contingent on the successful completion of the merger.

Wells Fargo indicates that most Merger Arbitrage strategies aim to exploit this post-announcement price spread. The effectiveness of these strategies largely depends on the size of the residual premium, the time it takes to finalize the merger, and the risk of the merger not being completed.

Strategists note that current premiums and the duration needed to close deals have remained consistent with long-term averages, yet there has been a sluggish recovery in deal activity. They suggest that the prevailing high-interest rate environment, combined with corporate leaders’ lack of confidence and slow economic growth, may be hindering the pace of transactions.

The report concludes with a hopeful outlook: “We continue to look for green shoots, and a more accommodating financing environment may be enough to spur greater levels of activity in the coming quarters.”

On a related note, Fed Chair Jerome Powell indicated recently that interest rate cuts are on the horizon, although he did not provide specifics regarding timing or extent. He remarked, “The time has come for policy to adjust” during his keynote speech at the Federal Reserve’s annual conference.

Powell also reviewed the factors that led to the Fed’s 11 rate hikes from March 2022 to July 2023, acknowledging progress made in controlling inflation and expressing that the Fed can now focus equally on maintaining full employment.