The long-awaited interest cut finally happened in mid-September, when the United States Federal Reserve reduced rates by 0.5%. The federal funds rate has been in the 5.25% to 5.50% range since July 2023. The new range is 4.75% to 5%.
The decision marked the first rate cut since March 2020, while the 0.5% is the largest reduction since the global financial crisis in 2008.
The move comes as inflation continues to cool from its mid-2022 9.1% peak and as the Fed’s 2% target comes into clearer view (the Consumer Price Index was 2.5% in August). It also means a more favorable borrowing backdrop, no doubt music to many operators’ – and consumers’ – ears. On paper, such a move should facilitate more investment and spending. That said, don’t expect the rate cut to be a quick fix to solve for an otherwise tough operating environment.
“This can’t be construed as a bad thing. Is it a silver bullet? No. What’s happening now is multi-layered. A lot of operators are in a super uncomfortable holding pattern, because they’re waiting for the consumer base to readjust to the cost of living and that just takes time,” said Full Course founder and CEO Lauren Fernandez. “It takes time for the interest rate to trickle down to what a consumer will see. From an inflationary perspective, rate cuts are not necessarily what it’s going to take to have appropriate correction.”
Where perhaps the biggest tailwind is going to come from is banks’ lending activity. Fernandez said, many banks, especially regional and local establishments, have largely stayed on the sidelines through the high-interest-rate period but, “hopefully this is a signal flare to them that it’s a good time to start lending again.”
“A lot of operators who have been pounding the pavement for the last 12 months trying to find capital sources to grow need to go back to traditional lending structures. In a couple of weeks, it’s worth revisiting lenders you previously spoke to to see if they’re open to lending now,” Fernandez advised.
Plenty of operators were caught off guard by the consumer pullback so far this year after a robust 2023. And, for some, this year has turned into yet another year of survival (and debt accrual).
“Many had to do what it took this year, including taking double-digit interest-rate loans, just to make it,” Fernandez said. “If you have debt on your books that is in the double digits, I would submit you look at a way to refinance that is more traditional from a regional or local bank.”
Importantly, Fernandez cautioned that now is not the time to get a loan and keep growing just because rates have become more favorable. Despite the recent cut, levels remain “sufficiently high” to target what the Fed committee called “lingering price pressures in the economy.”
“Now is the time to take a beat,” she said. “Look at your debt stack and how you can restructure before you take out more to grow. This should be a retrenching moment for a lot of brands, because debt isn’t always the answer when it’s expensive. Adjust to reality – debt is no longer going to be cheap. It’s important to be patient and build cash reserves and get your unit-level economics in order.”
Growing simply to drive sales, she adds, does nothing but “cover up a multitude of sins.” With sales down across much of the industry, many restaurants’ unit-level economics can’t support the ensuing lower profit margin. The result, Fernandez said, is a lot of breaking even to cover food, labor, and other costs.
“If your unit-level economics put you in a position to get debt and now you can’t service that debt, your focus should be on preserving as much margin as possible and making your units as efficient as possible,” she said. “Few brands are putting up positive profit margin right now. Unit-level economics should always be the priority, and especially now.”
Notably, the rate cut should provide some relief to consumers who have maxed out their credit in the past couple of years. Fernandez said she’s “cautiously optimistic” they’ll return to restaurants and traffic will eventually turn positive.
“We don’t need to have 2023 levels of excitement about high sales volume,” she said. “If you can float a profit margin at a low sales volume, like many have been doing, imagine what you can do when sales float back up. That’s why I’m bullish on deals right now.”
How interest rate cuts are informing strategy shifts for a big and small brands
From an operator perspective, James O’Reilly, CEO of Ascent Hospitality, parent company of Huddle House and Perkins, said the more favorable interest rate environment “modestly improves” his company’s investment outlook.
Meanwhile, the investment strategy at Chicago’s Adalina, an upscale modern Italian restaurant in the city’s Gold Coast district, won’t change much in the near-term post-rate-cut. Long-term, however, is a different story.
“For future projects, [the rate cut] will have an impact on how we raise capital, including our willingness to finance major equipment and the rates of returns our investors expect,” said partner Jonathan Gillespie.
In the meantime, neither O’Reilly nor Gillespie expect consumers to come rushing back to restaurants right away because the interest on their overleveraged credit cards is a bit lower.
“We are hopeful this move will have a beneficial impact on consumer discretionary spending, but we need to watch and evaluate. Consumers want to eat in restaurants more often, but their visit frequency to our industry has been negatively impacted by the cumulative inflation impact,” O’Reilly said. “We expect restaurant customers to remain very cautious in at least the short term; (but) we are hopeful they will experience a noticeable benefit from recent rate cuts. If they do, we expect to see corresponding improvements in consumer optimism and visit frequency.”
Gillespie said the rate cut hasn’t moved the needle on his level of optimism because it occurred during an election year and has been largely priced into the market.
“That said, continued cuts post-November, and the easing of political uncertainty, could definitely impact my outlook moving forward,” he said. “I believe that interest rates alone will not impact consumer spending. I do believe, over time, access to cheaper funds and overall improved sentiment toward the economy with reductions in inflation, will lead to guests dining out more frequently.”
Economists expect the federal funds rate to decline by another 50 basis points yet this year, with two more Fed meetings planned – Nov. 6-7 and Dec. 17-18.
Contact Alicia Kelso at [email protected]
