The Massive Gulf Between Normal and Today

We see a continued modest capital formation environment. Bon Secours Mercy issued approximately $400 million of tax-exempt debt in a very difficult market. The transaction got done, but put bonds needed to be repriced higher while the traditional fixed rate bonds garnered only modestly sufficient support. The twin headwinds remain a very challenged fixed income environment paired with strains on healthcare sector credit.

SIFMA reset this week at 1.96%, which is approximately 63.6% of 1-Month LIBOR and represents a +57 basis point adjustment versus the September 7, 2022, reset.

What’s Up With That?

As expected, the Fed raised short-term rates another 75 basis points at its September meeting to a target range of 3.00% - 3.25%. The 75 basis point decision was unanimous and a majority of participants indicated expectations that the target range would increase by 1.25% by year-end to 4.25% - 4.50%, which is higher than what was communicated in July. During his post-meeting press conference, Chair Jerome Powell re-emphasized the Fed’s commitment to regaining price stability over all other factors in addition to noting that inflation remained high despite diminishing supply chain problems, which in his words is “not where we wanted or expected to be.” Uh oh.

There is a massive gulf between where we are today and normal. As a quick refresher on the “where we are” front, during the period January 2008 – present:

1. The Fed Funds target rate was set at 0.00% - 0.25% over 60% of the time
2. The Fed balance sheet grew from $0.8 trillion to $9.0 trillion
3. Federal debt outstanding increased from $9 trillion to over $28 trillion

We monetized two economic dislocations and we are still confronted by enough “never done that before” threads for me to think we remain closer to uncertainty than risk on Allison Schrager’s “unknown-to-risk” continuum. And while team Fed is now fully hawkish on inflation, there are so many areas where it seems like we need Diondre Cole (aka Kenan Thompson) and his relentlessly exuberant query, “What’s Up With That?”

• Labor as a Supply Chain. The last time the Fed was going toe-to-toe with entrenched inflation (1970s – early 1980s), the U.S. economy and labor force was more distributed, including a significant manufacturing base. We are now a services economy, and the question is whether that is equally, more, or less responsive to the blunt instrument of Fed rate hikes? In a services economy, labor is the main supply chain ingredient and there are certain sectors—like healthcare—where it is difficult to imagine the bid for workers moderating in response to rates. In addition, labor participation rates suggest we somehow lost a whole lot of workers, and no one has offered a compelling explanation for where they went and whether all, some, or none are ever coming back. So how much economic contraction is needed before we regain enough labor equilibrium for wage pressures to moderate?
   
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• Fiscal-Monetary Imbalances. The Fed is all-in on battling inflation, but how will this work if the fiscal side of the house doesn’t share that priority? Regardless of how you feel about the policies themselves, things like releasing oil from the Strategic Petroleum Reserve, or cancelling student loan debt, or having individual states send tax surpluses back to citizens are all variations of demand-side stimulus. Will having an ongoing series of accommodative fiscal initiatives eventually force an even more restrictive than expected monetary policy?
• Unwinding the Fed Balance Sheet. In 2008 the Fed opened the central bankers’ Pandora’s Box and unleashed quantitative easing into the world. That led to the idea that the Fed could manufacture a continuous series of soft landings, which led to this moment and a central bank with a $9 trillion balance sheet (mostly consisting of Treasury and mortgage-backed securities). Part of the Fed’s stated inflation fighting plan is to “gradually” reduce its balance sheet. They started with runoffs of $47.5 billion in each of June, July, and August, which will increase to $95 billion in September and stay there for the foreseeable future. A September 19, 2022, article in Bankrate titled “This Federal Reserve Policy You’ve Never Heard of Could Have the Biggest Effect on Your Wallet” included the following quote from Kristina Hooper, the Chief Global Market Strategist at Invesco, about the general topic of quantitative tightening: “This is the wild west of monetary policy. We are in the land of experimental monetary policy. We just don’t know how this is going to play out.” Another uh oh.

Ken Kaufman released a recent commentary on “The Sobering State of Hospital Finances,” in which he stresses that the current imperative for hospital management teams is cost cutting. This is a critical truth—the only path through this mess is improving core operations. But the parallel imperative is positioning total financial resources—cash, investments, credit, capital—to create the time and space needed to accomplish the operational restructuring, especially if that restructuring is going to take years instead of months.

One of the foundational Kaufman Hall financial management principles is that balance, equilibrium, and sustainability are the hallmarks of resilient organizations. Every part of the healthcare financial equation is out of balance right now, so the core focus must be identifying which levers can get pulled to either get back to balance or to reduce the risk of remaining unbalanced:

1. Playing Offense: What does it take in different parts of the business to achieve balance? What can we do today versus what requires either time or external adjustments?
2. Playing Defense: How big is the gap between what we need to do versus what we can do? How do we protect the organization from that gap and from externalities that might increase the scale or duration of imbalance?

Arguably the greatest challenge of this moment is the range of possible outcomes. There are reasonable scenarios across the good-to-bad continuum and every organization must determine its own best response. Cost and every possible form of operational performance improvement are critical proactive steps, as is using strategic resource allocation as the framework to best support moving from uncertainty to risk to stabilization.