The end of the global interest rate cycle is material positive catalyst for clean energy – while clean energy is a secular growth thematic, its high sensitivity to interest rates creates a cyclical overlay

Key points

• During September, the US Federal Reserve cut interest rates for the first time since the depths of the COVID-19 pandemic in March of 2020. Interest rates in the United States went from 0% in March 2022 to 5.50% in July 2023, the steepest, longest hiking cycle since the 1970s.
• The clean energy sector has been highly sensitive to interest rates. Rising interest rates have been the key fundamental factor driving negative sentiment towards the sector, resulting in capital outflows and short interest in the related equities and stock indices.
• The interest rate cut was the main condition precedent for the sector’s recovery.
• The US presidential election remains the key area of uncertainty for the sector, in our view. This stands to be resolved by 6 November this year.

Introduction

As you will recall, we have published numerous insights in relation to clean energy’s sensitivity to interest rates. Rising interest rates have been the key fundamental factor driving negative sentiment towards the sector, resulting in capital outflows and short interest in the related equities and stock indices.

Interest rates in the United States went from 0% in March 2022 to 5.50% in July 2023. This resulted in a material increase to borrowing costs for things such as projects to build solar farms, which rely on project finance for the majority of their development cost. The rate of change of interest rates during this period created temporary uncertainty in relation to the cost of capital, further compounding the issue.

Notwithstanding this backdrop, as you will recall we have written in a previous insight, the clean energy sector on the whole has continued to experience robust growth. Onshore wind was the only segment globally which experienced a decline in 2023.

The clean energy sector clearly welcomes the end of the interest rate cycle, which was the steepest, longest hiking cycle since the 1970s.

Interest rate cut

During September, the US Federal Reserve cut interest rates for the first time since the depths of the COVID-19 pandemic in March of 2020.

The interconnected nature of financial markets means the US interest rate cut created scope for other central banks to ease (on the basis that interest rate differentials between countries can drive significant capital flows and movements in currencies – US interest rates are particularly important given the US dollar is the global reserve currency). The conditions which allowed the US cut were likely a decisive factor for the European Central Bank cutting rates a week earlier, the Bank of Canada at the beginning of the month and China which announced a range of measures following the US interest rate decision.

Chinese interest rate cut and stimulus

China has recently reiterated its aim to achieve economic growth of approximately 5% in 2024. This objective has been practically supported by an interest rate cut from the People’s Bank of China combined with a raft of additional measures all aimed at supporting and stimulating its economy including:

• A cut to the reserve requirement ratio (RRR), cuts to short and medium-term borrowing rates and hints that it may issue additional government bonds;
• Support for the real estate sector through reduced interest rates on existing mortgages and reduced capital requirements to buy a second home; and
• Support for the stock market including refinancing bank loans to inject liquidity to help firms buy back their own shares as well as allowing institutional investors to access liquidity using stock holdings as collateral.

The economic data

The interest rate cut in the US (and other major economies) was ultimately enabled by cooling US inflation and employment data.

Inflation data

In terms of inflation, the August reading of the Consumer Price Index (CPI) ticked down to 2.5% year-over year from 2.9% in July and the US Federal Reserve’s preferred measure of inflation, the Personal Consumption Expenditures Price Index (PCE), also contracted, falling to 2.2% from 2.5%. Core PCE (a measure of underlying inflation) increased modestly to 2.7% year-over-year, not benefitting from the movements in food and energy prices. While inflation continues to drift lower, it remains slightly elevated relative to the US Federal Reserve’s stated target of 2%.

Employment data

Continuing the trend from last month, US labour market data came in weaker than expected as the US economy added only 142,000 new jobs during August¹ relative to consensus at 165,000. While on face value this was an improvement on July’s 114,000, the July number was retrospectively revised lower to only 89,000 which overshadowed the August number.

As we have previously described, while a cooler labour market is one of the prerequisites for interest rate cuts, the labour market slowing down by this magnitude creates concern that the US economy is cooling too quickly and is at a greater risk of a recession.

Rising recession risk

Tempering the risk of recession, US GDP grew at 3.0% (on an annualised, quarter over quarter basis), coming in slightly ahead of expectations for 2.9%, which may point to a softer landing (as opposed to harder landing or recession) which would be supportive of a robust level of risk appetite.

Implications for the clean energy sector

Clean energy’s main cyclical macroeconomic driver has now shifted from a headwind to being tailwind, which is the key condition precedent for the sector’s recovery. This reinforces our forecast for the renewable energy, electric vehicle and energy storage industries to be 3-4x, 4-5x and 10-20x larger respectively by 2030.

You will recall that earlier this year we published an insight including case studies on deep cyclical sectors (and their inevitable recovery from cyclical downturns) which is highly relevant at this time.

The US presidential election remains the key area of uncertainty for the sector, in our view. This stands to be resolved by 6 November this year. During July we published an insight exploring the implications for clean energy under the scenario of a second Trump presidency. There are excellent arguments to believe that it would not be as negative for clean energy as some of his rhetoric would suggest. A great example is that installed solar capacity in the US more than doubled while he was last in office. The election remains a source of uncertainty to monitor and our report remains relevant.

Footnotes

¹ US Employees on Nonfarm Payrolls Total Month-over-month Net Change