In the darkest days of the COVID-19 pandemic in 2020, global ECM activity was picked off the mat and delivered a knock-out year and a half that broke issuance records. At the time, one of ECM Pulse’s authors asked an investor how he could be so happy with taking risk at a time when the whole world seemed to be falling apart. “It’s simple,” he said. “You can’t fight the Fed.”

Last week, the US Federal Reserve finally joined the European Central Bank and Bank of England in cutting interest rates, with a bumper 50bp rate cut. There are hopes that this will fuel equities and encourage more IPO issuers to bring assets to public markets.

A US ECM banker noted that a single cut is unlikely to move the needle and that investors wanted to see a sustained period of rate cuts.

According to CME Fedwatch, rates traders are predicting just that, with hopes the US central bank to move quickly on rate cuts, with a majority expecting the target Federal Funds rate to be between 275bp and 325bp by the end of 1H25, down from the target rate of 475bp to 500bp set last week.

“I think it is a positive for the market, clearly one of the main obstacles we still are having is the IPO market and it is still in a pretty deadlocked state, but the rate cuts could do something to help break that impasse,” said a European ECM banker.

Historically a shift in the direction of interest rates from the US Fed has a beneficial effect on both US and European ECM volume, with ECB and BoE historically moving in the same direction.

*Data as of Sep19, 2024

Simply put, the reason investors can’t “fight the Fed” is because lower rates make equities far more attractive as a comparative risk asset. Bond yields drop as rates go down which then pushes asset managers into stocks to seek greater returns.

IPOs can provide even greater rewards, if deals are priced at a discount and then traded up, making the asset class theoretically far more attractive in a lower-rate environment.

“In recent months, rates have been trending down in anticipation of cuts, leading investors to reconsider where to find returns,” said a second US ECM banker. “Previously, the bond market was attractive on a risk-adjusted basis, but with bonds rallying and rates declining, the focus is shifting towards equities. We’re seeing fund flows moving from fixed income into equities, and this trend is likely to continue, with investors adjusting portfolios to chase higher returns.”

A rising tide

For IPOs to be the beneficiary of Fed rate cuts funds would have to start to flow more broadly to wider equity markets rather than the small basket of large US, mainly technology, stocks that have dominated portfolios in the past two years, like the much vaunted Magnificent 7.

Bank of America’s August Fund Manager’s Survey showed a heavy bias to large-cap US equities in the holdings of surveyed fund managers.

Flow data from the bank and EPFR Global also shows that while there have been cumulative inflows to equities this year, all of that has flowed to ETFs with active long-only managers seeing significant outflows this year.

This means that IPO issuers, pushing for high equity valuations based off the general market, are often being benchmarked to peers that are not growing, but have stock prices which are often falling, making prospective listing valuations look prohibitively expensive.

“If you look at the IPOs of Planisware [EPA:PLNW] and Renk [ETR:R3NK], those were deals that failed and then were brought back,” said the European banker. “The issuer valuation targets didn’t change but the peers traded up and that meant the IPO value became more compelling. A broader capital flow to equities will hopefully lift many of these peer stocks and help issuers get closer to their target valuations.”

As peers rise with more capital flowing to equities, IPO candidates will have far greater chances of hitting the valuation levels they want to achieve.

“For the IPO market, we’ve been waiting for a recalibration of expectations — where private companies’ valuation hopes to align with what the public market offers,” said the second US banker. “As expectations moderate and valuations recover, the gap will close, allowing deal flow to accelerate.”

Don’t push the envelope

If broader equities are the beneficiaries as investors switch from fixed income to stocks, it could prove a boon for IPO candidates, particularly those in sectors where peers are booming.

“We know lots of sponsors who will be thrilled with the Fed moves last week and are watching any IPOs from now to the end of the year to see what the demand is,” said a second European ECM banker.

In Europe, books are set to open on the IPO of Springer Nature, while Polish retailer Zabka Group has also announced it is seeking to list on the Warsaw Stock Exchange.

The banker noted he is optimistic about the European IPO pipe in 1H25 but said that sponsors, sellers, and their advisors, must work hard to make sure they can be at the starting line as soon as the window opens.

Even with a monetary policy wind blowing the sails of equity markets, ECM investors will likely remain diligent and disciplined around pricing, too cognisant of the losses taken from IPOs which pried during the last Fed rate cut cycle in 2020/2021 to throw caution to the wind.

“IPOs will be able to launch because comps trading up will make target valuations more achievable,” added the first European banker. “But issuers need to be pragmatic they can’t think about chasing the market up on valuations. Discounts are just going to be wider than they were in the past and the direction of interest rates I don’t think changes that too much.”