Current Funding Environment
As expected, on Wednesday the Federal Reserve raised the Fed Funds rate by 25 basis points to a target range of 5.25% - 5.50%, the highest rate in over 20 years. In post-meeting comments, Fed Chair Jerome Powell covered the waterfront of possibilities by observing that there might be additional rate increases over the balance of this year, there might not be any more rate increases, and the Fed staff is no longer forecasting a recession in their models. Then on Thursday, the Commerce Department reported that the U.S. economy grew at a 2.4% annual rate in the second quarter, which was above expectations and seems to support the soft landing (no recession) thesis. Meanwhile, every statistic continues to describe a generally tight labor market, which leads to the overhanging threat that we might not yet be done with inflation. There are conflicting indicators and policy options, but so far, the Fed has maintained the priority of price stability and the 2% inflation target.
| 1 Year | 5 Year | 10 Year | 30 Year | |
| July 28—UST | 5.39% | 4.20% | 3.97% | 4.03% |
| v. July 14 | 0.06% | 0.17% | 0.15% | 0.11% |
| July 28 –-MMD* | 3.17% | 2.66% | 2.57% | 3.51% |
| v. July 14 | 0.14% | 0.01% | -0.02% | 0.00% |
| July 28—MMD/UST | 58.81% | 63.33% | 64.74% | 87.10% |
| v. July 14 | 1.96% | -0.69% | -3.07% | -2.44% |
| *Note: MMD assumes 5.00% coupon | ||||
SIFMA reset this week at 3.98%, which is approximately 75% of daily SOFR* and represents a 178 basis point adjustment versus the July 12, 2023, reset.
*Daily SOFR quoted as of 7/27/2023 – 5.31%
Make or Break Transitional Moments
What all the conflicting indicators across the economy suggest is that we have moved out of the “crisis” stage of post-COVID inflation and into the “stabilization” stage, where we may bounce around before we get enough directional clarity to declare normalization. Challenges remain, including the unknown lag effect of the Fed tightening (have they already gone too far?), but also the array of high impact stimulative versus contractive forces (ranging from crude oil prices to federal spending) that are in play but outside the Fed’s control. There is no clear road map and—absent a sharp increase—a major concern is inflation that hangs around but doesn’t get all the way to the Fed’s 2% target, especially if wage or other labor factors suggest the possibility of resurgent pressure. Richard Clarida, former Vice Chair of the Fed, observed that “if we don’t get a deceleration in wages and we don’t get a pickup in productivity, then we’re not going to hit our inflation target.” And not meeting our inflation target at best means an extended and bumpy stabilization process and at worst means drifting back toward crisis-dislocation (which could include a recession).
This macroeconomic construct seems to mirror what is going on across the not-for-profit healthcare sub-economy. My colleagues Robert Turner and Lisa Goldstein hosted our most recent rating agency webinar and then published a summary of the key themes that noted: “the rating agencies describe 2023 as a ‘make or break’ year for rated organizations. The period of rapid deterioration in financial performance is likely behind us but the pace of recovery has been slower than expected. Organizations that are seeing continued operational losses in 2023, a slower pace of recovery, and a weakened balance sheet are most at risk of a downgrade. Organizations that can demonstrate a clear pathway forward and have maintained balance sheet strength will be in a better position.” The healthcare sector may also have moved from crisis into stabilization, but this stabilization might prove messy and long and may carry a wide distribution of possible outcomes (sectoral volatility, which may be a headwind for credit positioning and pricing).
A soft landing for the Fed means we arrive at the 2% inflation target without a recession. Healthcare’s soft landing is operating and investment entity recovery that stabilizes credit positioning and facilitates capital formation. Kaufman Hall’s recent National Hospital Flash Report offers hints of operating progress, but maybe a more immediately hopeful thread is the balance sheet lift attached to the prospect of a Fed soft landing. Recall our construct that the typical not-for-profit healthcare organization is the combination of three equally sophisticated but very different disciplines (operating entity, financing entity, and investing entity) and that the last 12+ months have been a “no haven” environment during which each of these entities has been a net user versus a contributor to credit and capital capacities. The investment entity has made a lot of progress as the inflation crisis has moderated, but especially as the prospect of a no-recession resolution has gained traction. A July 26 article in the Wall Street Journal showcasing the Dow’s longest streak of consecutive gains since 1987 included the observation from the chief investment officer at Osterweis that “risk appetite is off the charts.” This is great news for the prospect of reflating healthcare balance sheets, but lingering headwinds suggest the investment entity may not yet be back to its role as a reliable credit and capital anchor:
- Many organizations continue to spend down investment resources in response to continued weakness in operations and unwillingness to access external debt; and
- The favorable market thesis might get quickly (and significantly) derailed by any number of things ranging from sticky to rekindling inflation to a lag recession or one brought about by the need for additional Fed tightening.
Stabilization was always going to be hard, and it is proving to be just that; and stabilization was always going to be about great resource management, and it is proving to be just that. Crisis is about repositioning resources for liquidity and urgent risk management; normalization is about repositioning resources for maximum return; the in-between of stabilization is about actively managing resources in response to shifting risk-return capacities. No different than the Fed with inflation, healthcare leaders must respond to an array of conflicting pressures and signals bubbling up from each of the three entities they manage. The success imperative is always responsive resource management, which is defined by three characteristics:
- It is the product of an intentional, comprehensive, and disciplined process/framework that happens at the enterprise rather than the entity level (it offers integrated rather than distributed decision-support).
- It assumes the unconditional primacy of the operating (mission) entity and assumes the financing and investing entities occupy active supporting roles.
- The objective is either risk-return balance or some level of intentional imbalance that is both understood and embraced by management and governance.
