The Fed thinks catastrophe is coming for US businesses

• Fed economists just rang the alarm on the historic percentage of distressed US companies.
• Around 37% of firms are in major trouble, which could worsen the fallout from the Fed's rate hikes.

Federal Reserve economists just said a historic surge in the percentage of distressed American companies could worsen the fallout from the US central bank's fight against inflation.

"The share of nonfinancial firms in financial distress has reached a level that is higher than during most previous tightening episodes since the 1970s," Ander Perez-Orive and Yannick Timmer said in a recent note.

The upshot is that the Fed's hikes to interest rates — intended to curb the pace of price increases by raising borrowing costs — threaten to have a magnified influence on business investment, employment, and economic activity.

That's because debt-ridden companies will likely balk at spending money on new equipment or facilities, hiring more people, and ramping up production.

The percentage of troubled US firms stands at about 37%, the pair of researchers said. That could lead to the Fed's rate hikes having some of the most devastating effects of any of its tightening cycles over the past four decades, they added. The full extent of the damage should become clearer over the next 18 months, they said.

The Fed has already hiked interest rates from nearly zero to north of 5% since spring 2022 in an effort to curb inflation, which spiked to a 40-year high of more than 9% last year. After 10 consecutive rate hikes, the central bank has helped bring inflation down to about 4%.

Fed Chair Jerome Powell and his colleagues skipped a rate hike this month, against a backdrop of cooling inflation and emerging cracks in sectors such as banking and commercial real estate. But they've signaled they could raise rates a couple of more times in the months ahead.

The prospect of further hikes has some investors worried that the Fed is going overboard in its fight against inflation and might tip the economy into recession unnecessarily.