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Conventional Wisdom Says M&A Slows as Rates Rise. History Shows a Different Story.

The massive amount of dry powder in the private markets and the need for companies to restructure will keep M&A strong in 2022, according to Deloitte.

Despite slowing economic activity and a hawkish central bank, mergers and acquisitions are expected to remain strong in the second half of 2022. 

While deals can slow when rates rise as the cost of borrowing goes up, decades of data show something else happening. Historically, the M&A markets have hardly been affected by interest rate moves. According to the latest M&A analysis by Deloitte, the correlation between M&A deal value and the Fed Funds rate over the past 40 years has only been “moderate.” During the 1980s, the average correlation was actually negative (-0.66), but it turned positive in the 1990s (0.66) and 2000s (0.87). In the 2010s, the correlation dropped to a mere 0.12, signaling there was less certainty about the connection between M&A activity and the macroeconomic indicator. 

Given that historical data suggests that capital costs and inflationary factors have little correlation to M&A, “I think something would have to be pretty significantly different in the market to change that,” Mark Purowitz, principal at Deloitte’s U.S. M&A Consulting Services, told II in an interview. 

Another reason for Deloitte to be confident about the outlook is that M&A activity tends to recover quickly from crisis conditions. During each recessionary period from 1980 to 2021, M&A deal value never dropped for more than two consecutive years, according to the report. 

In addition, the massive amount of dry powder in the private markets also will help the M&A markets stay active. Private equity firms are sitting on $2.5 trillion in non-deployed capital as of 2021. Many will be ready to invest once they have more clarity on which part of the markets will benefit from rising capital costs and inflation, according to Purowitz. “They’re waiting to understand to what degree the markets recalibrate, much like they did in the pandemic,” he said. Take-private deals, for example, are a sweet spot for PE firms when the public markets sell off. Many allocators, such as sovereign wealth funds, pension plans, and family offices that have started to handle M&A transactions in-house will also be in the market, according to Deloitte. 

The fact that companies across all sectors have been reshaping their businesses in response to rising uncertainties is also conducive to the M&A market. According to Purowitz, companies made either defensive or offensive moves through M&A deals during the pandemic, which is likely to happen again in the current macroeconomic environment. “We are seeing evidence of activity in building resilience, so that market conditions, like the [ones seen during the] pandemic, will have significantly less of an impact going forward,” he said.

Deal activity may be lighter in sectors less affected by the pandemic and where there isn’t a lot of pent-up demand, including financial services, healthcare, and life sciences. Last year, the number of asset management transactions was the highest in 20 years. Deals in the healthcare industry have already dried up this year, after a frenetic 2021. 

But sectors like transportation, entertainment, and energy “are just entering into the later stages of the recovery cycle,” according to Purowitz. “You’re seeing evidence [that] deals clustering in those sectors [are] happening.” 

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