As the Fed announces higher interest rates, struggling companies are declaring bankruptcy.

• According to a 2021 Federal Reserve estimate, about 10% of U.S. companies are classified as 'zombie firms'.
• Zombie firms are going bankrupt due to the Federal Reserve's swift interest rate hikes.
• According to S&P Global Intelligence, 516 companies filed for bankruptcy in the first 9 months of 2023.

In the US, 516 publicly listed companies filed for bankruptcy between January and September 2023. Many of these firms have been able to survive for several years with mounting debt and declining sales. "The share of zombie firms has been increasing over time," said Bruno Albuquerque, an economist at the International Monetary Fund. "This has negative effects on healthy firms in the same sector." Zombie firms are unprofitable businesses that remain afloat by taking on new debt. Banks lend to these weak firms in the hopes that they can reverse their trend of declining sales.

Ensuring timely winding down of unhealthy firms is crucial for a healthy banking system and financial sector, as stated by Kathryn Judge, a professor of law at Columbia University.

The Federal Reserve reports that the share of zombie firms decreased after Covid-19 emergency stimulus measures were implemented, as banks are refusing to keep weak firms in business with favorable extensions of credit. Despite the increasing weight of interest rate hikes, the balance sheets of U.S. firms remain healthy, with the effective federal funds rate reaching 5.33% in October 2023, up from 0.08% in October 2021.

According to Goldman Sachs' chief credit strategist, Lotfi Karoui, the increase in interest rates over the past five to six quarters has led to a resurgence of cash holdings. This, in turn, has put limitations on risk assets.

The Fed anticipates that interest rates will remain elevated for an extended period, according to Fed Chair Jerome Powell, who stated this at an Economic Club of New York speech on October 19.

The Fed is facing a challenge with unprofitable "zombie" firms in the U.S.