Interest Rates and Rating Interest
The tech and venture corners of the universe are large and rising. There are more people in the business and more people interested in the business than usual. Perhaps more than at any time, there is huge general and insider attention. As much as tech’s ranks have grown, the space remains unusually insular and inwardly focused. Outside the walls of this subculture folks are increasingly nervous about the direction of asset prices. This is particularly true regarding the price trend in risky assets. The world hangs on meeting notes, phrasing and prognostication regarding long anticipated interest rate normalization. The vast preponderance of opinions suggest that rates are about to move back toward normal ranges from the record breaking lows held for so long since the Great Recession.
In 2008 rates were cut to never before lows and have been kept there ever since. Over the last 60 years, the average Fed Funds rate was 5%, today it is 0.25%. Thus, we have rates at 1/20th the long run average level since the Korean War era. We have been waiting for this to normalize and this debate and waiting game has buffeted markets and asset prices.
Very low rates push investors to take risk to get returns. Risk assets have benefitted greatly. Illiquid assets have also gained as the cost of money is set and kept at very low rates. Pre IPO technology firms have benefited twice. First, the push into risk assets helps draw excitement to allocation to this class of risk assets. Secondly, the very low rate of interest reduces the cost to tying up monies over the large number of years that come between starting a firm and getting liquidity.
You are likely not used to discussing or pondering the relationship between rates and rate policy and appetite for tech investment. Tech-land has settled into a feast and famine pattern and usually maintains its sense of exceptionalism during booms. When booms end, there is general disbelief and sometimes a search for external causes of turbulence. We have been doing the unthinkable, or maybe just the less commonly thought. We have been asking, why don’t folks see tech investments as another class of illiquid, risk assets? We decided to look to share a bit of what we found.
A look back at the Fed Funds rate and the number of venture deals show that low rates have positive correlation with good numbers of venture backed IPOs. Low rates and falling rates are positive and high and rising rates have negative correlation. We sit at the end of the longest period of the lowest rates. This long period of low rates has coincided with an unusually strong venture and tech run. Likewise the duration of ultra low rates is uncommonly long, at 6 years and counting.
We expect a slow and less than dramatic rise in interest rates. We will likely see a cautious Fed slowly step up rates in .25 or .50% increments. These gentle steps and less than robust global and national macroeconomic environment suggest that rates will normalize slowly and partially. There has been a general drift toward lower rates over time. We don’t see this reversing. Whatever benefits tech and venture have gotten, and clearly there have been benefits, will slowly be withdrawn over the coming quarters.