Competing for capital in a higher rate world

By Mallika Khoobarry, Fixed Income Specialist

• Interest rates could stay higher for longer. Resilient growth and rising competition for capital may keep borrowing costs above the levels investors became used to in the 2010s.
• Capital is becoming more valuable. AI, energy projects and corporate refinancing are all competing for funding, potentially creating opportunities for investors who can provide it.
• Higher financing costs will create winners and losers. As capital becomes more expensive and less predictable, the gap may widen between businesses that allocate capital well and those that do not.

Investors watched closely as the European Central Bank (ECB), US Federal Reserve (Fed) and Bank of England (BoE) held policy meetings this month. Attention was focused on interest rates amid expectations that the conflict in the Middle East could add to inflationary pressures and prompt further monetary policy tightening.

Those expectations largely proved well-founded. The ECB raised interest rates by 0.25% for the second time this year, while the Fed increased rates by the same amount, its first hike since 2023. The BoE kept rates unchanged.

Yet for investors and borrowers alike, the immediate interest rate decision is only part of the story. Just as important is the degree of confidence businesses can have about future financing conditions.

In recent years, markets benefited from a high degree of visibility. Policymakers not only set interest rates but also provided increasingly detailed guidance on how they expected policy to evolve.

This helped shape market expectations and gave companies greater confidence when making long-term decisions around investment, refinancing and risk-taking.

Today, that environment is changing. As policymakers become less explicit about the future path of policy, the range of potential outcomes has widened. The challenge for markets is not simply that interest rates could move higher or lower, but that companies and investors have less confidence about which outcome is most likely. As a result, uncertainty around future funding costs has increased.

While policymakers have become less explicit about future rate moves, there are also reasons to believe interest rates may settle at structurally higher levels than investors became accustomed to during the last decade.

Economic growth is currently supported by a wave of investment in artificial intelligence (AI). If productivity gains from AI prove durable, they could allow economies to operate comfortably despite higher interest rates. And this, in turn, could raise the level at which monetary policy is considered neutral, leaving interest rates higher than they were during much of the previous decade.

Our analysis suggests that market pricing increasingly reflects this possibility. Investors appear to be assigning a greater probability to interest rates remaining elevated for longer, supported by the view that AI investment could reshape the economic landscape and support stronger growth.

This changing environment can influence how companies approach refinancing their debt.

Typically, companies refinance debt around a year before maturity, aiming to secure the most attractive borrowing terms. However, when policymakers provide less visibility over the future path of interest rates, there is a greater incentive to prioritise certainty over optimisation.

Companies may therefore choose to issue debt earlier than in the past, reducing the risk that an unexpected shift in inflation or monetary policy results in materially higher borrowing costs.

Recent market activity suggests this process may already be underway. A significant proportion of the refinancing associated with debt maturing in 2026 and 2027 has already been completed, shifting investor attention towards larger refinancing requirements later in the decade.

For investors, these developments matter because they are reshaping demand for funding across the economy.

On one side sits a growing pipeline of financing requirements linked to AI infrastructure. Investment needs now extend beyond the technology companies themselves and towards data centres, power generation and a broader ecosystem of supporting infrastructure. Together, these projects represent one of the largest investment booms in decades.

On the other side are the refinancing needs of existing borrowers seeking to secure funding earlier and reduce exposure to an increasingly uncertain policy environment.

So far, capital markets appear capable of supporting both sources of demand. However, financing conditions could become more challenging during periods of heightened market volatility or changes in investor sentiment.

For investors, this environment may create opportunities. Different financing needs across sectors, credit qualities and transaction types can increase dispersion within markets, allowing investors to be more selective and identify areas offering attractive risk-adjusted returns. In our view, maintaining exposure to assets capable of generating attractive returns in a higher-cost-of-capital environment remains imperative.

Crucially, none of this suggests that funding is scarce. Far from it.

Public bond markets remain open and issuance has remained robust. Private capital also continues to play an important role. Indeed, recent activity reflects this increasingly competitive financing environment. Large-scale transactions, including AI-related infrastructure projects, demonstrate that investor appetite for strategically important growth opportunities remains strong.

Traditional lenders are also becoming more active participants in the financing landscape. Early signs of stronger loan growth among US regional banks suggest that these institutions are becoming increasingly willing to support new lending activity alongside capital markets. 

So the backdrop remains supportive of economic growth and investment activity. And for investors, these trends – a potentially higher-rate environment, increased demand for capital – create greater choice. They reinforce the importance of being selective about where, and on what terms, capital is provided.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.