Lest we forget, Janet Yellen was not the first major central banker to hike rates 25 bps amidst an uncertain macro environment. Concerned about a continued increase in inflation in 2011, hawkish European Central Bank president Jean-Claude Trichet increased the benchmark rate 25 bps in two consecutive quarters. The benchmark rate went from 1% in 1Q to a 1.5% print announced in July 2011. The day of the second hike, Portuguese sovereign debt was downgraded to junk and in less than a year Greece’s creditors were forced to restructure the country’s sovereign debt to remain in the currency union. In the U.S. in 2016, easy money to the energy sector has caused high yield debt to crash similarly to European peripheral sovereigns such as Greece and Portugal in the wake of the financial crisis. We fully recognize the difficulty central bankers face when making pressing policy decisions due to the limited data they have at the time of decision and the need to act quickly and prudently. Central bank policy is only as good as a Taylor rule that aims to balance inflation, output and employment. In retrospect, that decision to hike in 2011 has been recognized as a major policy error.
Here are 4 charts that illustrate some of the potential consequences of the ECB’s policy error and the European sovereign debt crisis in private markets:
1. Portugal, Ireland, Italy, Greece and Spain PE deal flow
The PIIGS countries saw a sharp decline in PE activity and total capital transacted after the rate hike. Deal flow ground to a halt with higher rates and uncertain financing; conditions at the trough in 3Q 2012 prompted Trichet’s predecessor Mario Draghi to make a speech promising “whatever it takes” in London. European high yield debt continued to spike through 2012 given uncertainty in peripheral Europe. This uncertainty in the debt markets may have contributed to fewer buyouts as deals took longer to close. Activity levels did not recover to previous levels until mid-2014, the same quarter that National Bank of Greece (ATH: ETE) and Eurobank Ergasias (ATH: EUROB) received multibillion euro PIPE deals.
2. Germany, Austria, France, Benelux and Finland PE deal flow
Even in the more economically robust northern Eurozone, private investment activity has continued to trend downward since Trichet’s rate hike. We have seen bigger and bigger deals come through, but the overall number has declined. More recent concerns have illustrated the difficulties surrounding one monetary policy for a diverse basket of regional and industry considerations. In 2016, the solutions to the crisis have led to record amounts of negative yielding debt on bank balance sheets and liquidity concerns at Deutsche Bank. It remains to be seen to what degree this will impede the financing of PE deals, but dealmaker advisory in Europe has been relatively spared from downsizing, even as bonuses slip. 4Q 2015 was the worst for private equity since 2010.
3. Switzerland, U.K., Norway, Denmark and Sweden PE deal flow
Private markets in these non-Eurozone countries enjoyed a much more robust recovery from the global financial crisis. The quantity and value of deals in Switzerland, the U.K., Norway, Denmark and Sweden has trended steadily upward, only interrupted with a consistent seasonality. While 2012 was an off year overall, monetary sovereignty has allowed national central bankers to tailor policy to local economic realities in these countries. BoE president Mark Carney is on pace to step down as the first British central banker not to change rates since the 1940s, by stomaching slightly higher inflation. If there’s anything we’ve learned from this unprecedented experiment with accommodative monetary policy, it’s that low rates create an environment of steadily rising valuations. At some point something has to give as leverage ratios and credit markets can only go so far to support these deals.
4. European PE Fundraising
Pivoting to PE fundraising, European GPs are raising fewer buyout funds even as total capital raised has remained robust. Even though rates haven’t seemed to have a material effect on fundraising, we have seen a prolonged trend toward LPs writing bigger checks to a smaller circle of trusted managers. 2015 saw just 71 funds close, less than half the 2008 total of 160. The 2015 uptick in capital raised was bolstered by six €3 billion+ funds closed, led by the €6.75 billion EQT VII. As deal flow has plateaued in the U.S., and the Euro has weakened relative to the dollar, American GPs are looking to participate in transatlantic deals, making the market for private European companies more competitive.
The charts above show the prolonged downturn in European PE activity after the European sovereign debt crisis. Looking at the macro and dealmaking environment in 2016, many uncertainties remain. As the U.S. Fed looks to continue to hike rates due to promising job numbers, central bankers in Sweden, Switzerland and Japan have taken the opposite tact, taking the unprecedented step to lower rates below zero. In a year marked so far with fear and uncertainty, central bankers may need to climb down from their ivory towers and engage with dealmakers on the ground.