As we headed into 2023, the key questions were how much further interest rates would rise across the major global economies and what impact this would have on transactions and M&A. Now 2024 begins, questions have shifted to when central banks will cut interest rates and when the transaction market will spark back into life. 

The increase in rates from 2022 was swift and significant, and continued into 2023 as central banks grappled with soaring inflation. In the US the strategy seems to have been successful, inflation effectively back to target for the coming 12 to 18 months. Europe is slightly behind, but still expects a return to target inflation by the end of 2025. The UK remains the outlier, with higher inflation persistence. 

In 2024, the economic focus will move away from inflation and firmly towards economic growth – or, to be precise, the lack thereof. Global GDP is lacklustre and the lagged effects of higher interest rates will continue to have an impact through 2024 and 2025. The US looks set for the highest GDP growth, but is still materially below trend. The Eurozone and the UK are expected to flatline. Will both end up in recession by the middle of 2024? At present this seems more likely than not. 

Different views

In this zero-growth scenario, when considering the most recent announcements from the central banks and the subsequent market reactions, there are clear divergences in views on whether the central banks will cut interest rates. 

The Fed is no longer in rate-hiking mode, but has maintained its ‘tightening bias’. The median forecast for Fed Funds rate at the end of 2024 is 4.6%, and 3.6% at the end of 2025. Both the Bank of England and the European Central Bank are pushing back on the market’s assumptions that rate cuts are on the horizon. In the UK, they are currently forecast to be cut back to 4.5% by the summer, contrary to the Monetary Policy Committee’s statement that cuts are not being contemplated this year.

Whatever the timing, there is a growing acceptance that the new normal for UK interest rates is in the 4% to 4.5% range. This is critical for the transaction market, which needs to adjust to a higher cost of debt. And less debt market volatility is needed for transactional activity to be encouraged in 2024.

The number of $1bn-plus megadeals has declined by more than 50% since 2021 (a record year), but there has been steady mid-market activity. In addition, corporate acquirers with cash (or equity) to make acquisitions are in a strong position, with reduced private equity competition.

There is a focus on portfolio transformations, assessing what is ‘core’, with a spotlight on digitisation and, more broadly, generative AI themes. Dealmakers are highlighting value creation and performance enhancement opportunities to entice buyers. The cycle has turned to divestment opportunities – which creates buying opportunities and drives activity. 

There is more than $2.6trn of PE dry powder according to Preqin, but access to debt financing is needed to deliver returns. Sponsors are deploying more innovative financing structures and building investment ‘clubs’ to reduce the amount of leverage in a deal. Growth in alternative debt funding will provide much-needed liquidity – albeit at a premium cost. The large global sponsors are making platform acquisitions to gain exposure to this alternative asset class – Preqin also estimates there is more than $440bn of dry powder in private debt funds. 

A more stable interest rate environment, and reduction in debt costs, should make it easier for valuations to be agreed. Disparities between the pricing expectations of buyers and sellers are converging and should create a more stable market. 

Headwinds remain: the vulnerable geopolitical environment is a huge concern, and elections are due in 2024 with the uncertainty they bring. However, most participants expect deal flow to return in 2024 and for activity compared with 2023 to be substantially higher. There is more optimism and it feels like the tailwinds will be stronger than the headwinds of 2023. 

Jackie Bowie, managing partner and head of European business at Chatham Financial, a member of the Corporate Finance Faculty