Eric Hanselman

Welcome to Next in Tech, an S&P Global Market Intelligence podcast where the world of emerging tech lives. I'm your host, Eric Hanselman, Chief Analyst for the 451 Research arm of S&P Global Market Intelligence. And today, we're going to be discussing inflation and interest rates with returning guest, Malav Parekh, our Research Analyst. Malav, welcome back to the podcast.

Malav Parekh

Thank you for having me back, Eric. I had a great time during our previous meeting.

Eric Hanselman

And there's a lot to talk about, we think about -- back when we were talking in February. I don't know if we would have foreseen how things had proceeded. We just come off the results of our 451's macroeconomic outlook study. And we looked at a future that we're kind of guessing at, but a lot has changed since then. What are the most significant points?

Malav Parekh

You're right, a lot has changed. When we spoke last time, we were still a month away from the first interest rate hike. And at that time, we were already seeing high threat perception among businesses over both inflation and potential interest rate hikes. However, the overall sentiment among U.S. federal officials at the time was that the hikes were a necessary evil, and they were confident of a soft landing.

Eric Hanselman

Yes. And nobody is saying transitory right now, are they?

Malav Parekh

No. Now, soft landing is the new transitory. And at that time, they did -- that argument did have some things because businesses -- from businesses point of view, demand was high, sales pipeline is strong and most of the parameters bearing the inflation and supply challenges were in green, or in case of labor, moving in that direction. But today, the U.S. Fed is about to announce its fourth interest rate hike. But we know that from previous hikes, they've so far failed to put dent on inflation.

On economy itself, the government data is already showing 2 consecutive quarters of falling real GDP, which is widely seen as an indicator for recession, but government is refusing to call it so because it's pointing out good employee numbers -- employment numbers. So -- but the sentiment among businesses is really gloomy. According to our research, sales and outlook, demand and spending plans over the next few months are all in red.

Eric Hanselman

And if we think about what's happening right now -- well, actually, one quick aside. There may be some folks who are not listening to this just as it comes out, and the interest rate hike is going to have happened already, but we're recording this before the hike actually happens.

Malav Parekh

Yes. In our latest macroeconomic outlook, business trend survey conducted in June, we asked businesses on both the current situation and on circumstances that the interest rates remain high for another 12 months. One significant point from the survey responses that particularly stands out to me is that the proportion of U.S. businesses seeing inflation as the greatest threat to their sales have risen by nearly 70% from the end of 2021, comprehensively overtaking COVID and labor shortages, which dominated 2020 and 2021 as the greatest macroeconomic threat businesses are facing right now.

What we are seeing now is that in addition to soaring inflation, businesses are also experiencing threat from interest rates, which though not quite at the level of inflation or labor shortages, has become a fairly significant macroeconomic threat in the second quarter. Additionally, all covered industries have reported a sharp drop in demand in second quarter compared to the first. As a result, there's been a sharp increase in likelihood of a U.S. business reporting below-plan revenue for the June quarter, indicating that sales have fallen sharply in the second quarter, and it's likely to get worse in the third quarter with both sales pipeline and spending budget in red.

Eric Hanselman

So if you think about what's taking place in the market, we're seeing a lot of those concerns that we saw in the macroeconomic study early on, a lot of those fears about inflation and what the consequences were going to be seem to be being borne out. And it sounds like that negative sentiment is continuing.

Malav Parekh

Yes. And just to add one more observation from our macroeconomic outlook study, demand has long been vilified as one of the primary causes of inflation, but we've been seeing consistently in our survey responses that businesses believe supply chain disruption, energy prices and not demand to be the biggest causes of inflation.

And what's happening on the other hand is that the sentiment among businesses and -- is falling really, really sharply because these other problems are not getting addressed. And more problems are popping up. For instance, until a quarter ago, supply chain was the big problem. In the second quarter, we have rising fuel and energy costs as a problem in addition to supply chain. It's become a significant issue for our businesses. Higher wages continue to be a problem even when the government keeps saying that the employment, the data is great. High commodity prices are still a problem.

So these are all these are the factors which are pushing up. And nearly 78% of respondents do not believe the demand is the primary driver for inflation.

Eric Hanselman

Interesting. That's -- well, and if we think about all the things that you'd outlined, all the supply chain issues, the conflict in Ukraine, that whole set of things that are not demand-based, it's interesting to see that in the study, that's being echo -- that sentiment is being borne out in the study as well.

Malav Parekh

Yes, absolutely. And the study is basically saying that the interest rate hikes are already causing a lot of problems. The businesses which had traditionally high demand because of the supply chain bottleneck are also seeing a drop in demand, manufacturing, for instance. Our study shows that until the previous quarter, they had a very strong pipeline and a very strong demand, and sales sort of track record. However, while the prices are going up, their demand has fallen, too, and they are now at par with everyone else despite the supply chain bottleneck not getting solved, which is another indication that the economic situation is sort of slowing down sharply.

Eric Hanselman

And so we're seeing pullback in a number of different fronts in terms of both sentiment and some of the macroeconomic indicators that we've seen in the market as well. That sounds like that starts to lead us into a fairly complicated environment where a number of these different factors are coming into play. And I sort of wonder whether or not that becomes a self-fulfilling prophecy in that those concerns start to drive behaviors, whether or not the markets are actually supporting it because you identified that we've got reasonable labor capabilities. There are a lot of other aspects. But I guess I was wondering, what do you see businesses being concerned about around interest rates?

Malav Parekh

So interest rates directly impact the ability to spend and borrow. So it's still early days, but we're seeing real negative trends around interest rates.

Eric Hanselman

And the days of free money are over, right?

Malav Parekh

Yes.

Eric Hanselman

Well, and you could argue that we were in a strange environment where interest rates were so low. And now we're returning maybe to something that looks a little bit more like a normal operating environment, but it is enough of a change from what we've been living with for the last few years that this businesses have to start thinking differently about the cost of capital and a lot of these things.

I mean we see this in the merger and acquisition market. We were talking a lot about this in a couple of previous episodes ago, about the fact that with -- now that it actually really costs something to borrow, that changes a number of dynamics in a number of different places.

Malav Parekh

Oh, it does. And I think that was the goal by the policymakers to cut down on the business activities and focus more on savings and building capital. However, the problem that we're seeing is that lots of businesses are giving early signs in our study that they may not be able to pay back the borrowed money. There's also a significant rise in businesses in the difficulty of raising debt.

Eric Hanselman

It's now starting to get harder to raise money as default risk is up, all those early warning signs, I guess, that we could potentially see?

Malav Parekh

Yes. And not just that, the larger enterprises still will have some sort of negotiation power to sort of renegotiate some of those terms and restructure their debt. This will be a bit a pill to swallow for smaller businesses who do not have the negotiation power to reach that. So we're likely to see a greater number of smaller businesses shutting down or defaulting on debt compared to larger businesses.

Eric Hanselman

Yes. Well, it is an area of the market where there's a lot more pressure. And as you said, fewer options for smaller businesses in terms of what they can actually take advantage of and the tools they have at their disposal to be able to weather what are more difficult times.

Malav Parekh

Yes.

Eric Hanselman

To that end, I guess I've also seen -- it looks like labor statistics are cooling slightly. We saw unemployment claims up slightly. Certainly, labor demand is still high. I'm curious about what parts of the study and the study results that we see, are there pieces of this that reflect some of these shifts?

Malav Parekh

In our study, we covered a few things on labor, which is the trends of hiring and layoffs. And we also try to measure the shortages in the labor industry and what kind of challenges businesses are facing in hiring people. The U.S. government is technically correct in asserting that the employment situation is great. But the businesses sort of beg to differ. They still think it's a major threat to their business.

And the -- more than half of that of our U.S. respondents are facing hiring and rehiring difficulties even in our June survey. And the primary reason for that is competition for skilled workers, near 70% of our respondents attribute hiring difficulties to high competition for workers and 40% attribute to applicants lacking the required skill.

I think the big problem that the U.S. market is facing and U.S. businesses are facing is the lack of skilled workers. They need more skilled workers than there are in the market. And there are a number of ways to addressing that trouble, least of all is what Elon Musk is proposing. But...

Eric Hanselman

Well, we can't all be Elon Musk, but -- although it may be tempting for some. But a good point is that at the top end of that market is still really hot. There is still demand, and we've got those sorts of numbers. There's a lot that needs to get done.

Malav Parekh

Yes. And we expect the demand to remain high over the next several months because there is no easy solution or short-term solution to this. And the high numbers and employment rate numbers are literally sort of dodgy because that kind of talks about people who are in the workforce. And the big challenge that we've seen is a lot of people exiting the workforce.

So because of that, what is 63% or thereabouts in 2022 is not the same percentage of employment or unemployment rate in, say, 2019. And businesses -- more and more businesses because of the digital transformation are looking for skilled employees, employees with certain set of skills that can deal with the new way of working, and they are falling short.

Eric Hanselman

That's an interesting point, which is that it's that particular market segment is still so short in terms of skilled employees and especially skilled employees. That's the part that's really driving a lot of these concerns and potentially constraining business growth. I'm assuming that these are numbers in the study that the participants are identifying are currently issues that they're facing in terms of moving their businesses forward.

Malav Parekh

Yes. Skilled labor is -- we are seeing skilled labor. So in a separate report, we did an analysis on skill shortage. And there, we could see that larger enterprises and digital transformation leaders in particular was significantly more likely to face challenges in terms of hiring and rehiring than a conventional business.

And that kind of was one of the many sort of factors that our study showed, indicated that skilled labor shortage is a big challenge and it may not be solved anytime soon.

Eric Hanselman

Well, so what should organizations be considering as we sort of look towards the end of the year? And the study has got a set of different perspectives that sort of offer what the thoughts are about sentiment. What is that study? Are there takeaways in the study that people should keep in mind?

Malav Parekh

So one big thing that organizations understand is there are certain things that are in their hands and certain things that aren't. Businesses are already of the opinion that the winter has already set in, and they're preparing for like a long and cold one. We see widespread cuts and budgets, and they are already reporting drops in revenue and demand for their products and services.

So they have a fair bit of indicators. And what we've seen in the past in 2020 as well that when the economy slows down or is in trouble, the first action that most businesses do is just cut costs. And one of the indicators is that they've already slowed down hiring. But what they've also done is also slowed down layoffs because they actually do need the workforce. So there is some labor implications as well. So it's a very complicated path that they are navigating right now, and a lot will depend on how hawkish the U.S. Fed is and for how long they continue because the longer this interest rate hikes will continue, the harder it will be for a business to just rely on cost cuts.

Eric Hanselman

Yes. Well, in that point, our listeners who listened a little later may have an edge on what we know today, but we can certainly catch up and figure out what's happened in this complex set of interactions.

My main takeaway to this, Malav, is that there are a lot of unknowns in this environment, a lot of difficulties and that we're thinking about what we can do for tech. It's an area where organizations need to be ready for whatever the future happens to throw at them.

Malav Parekh

Yes, absolutely. And it's uncharted territory, so it will be interesting to see how economy or the policymakers respond and the businesses respond to this situation.

Eric Hanselman

It will be very interesting indeed. Well, we will have to definitely have you back again to once again see where things have gone. But for now, that is it as we are at time. But thank you, Malav. This has been great.

Malav Parekh

Thank you so much. It's lovely being here.

Eric Hanselman

And that is it for this episode of Next in Tech. Thanks to our audience for staying with us. And thanks to our production team, including Caroline Wright, [ Katarina Yakavyelo ], [ Ethan Zemin ]. And we want to welcome our intern, [ Michael Asaolu ], and the marketing and events teams and our studio lead, [ Kyle Canelosi ].

It's also time to start thinking about 451Nexus, our conference in October, where we're going to be back in person to talk about so much of what makes up the podcast. I hope that you can join us in Las Vegas.

And I hope you can join us for our next episode where we're going to be talking about language in technologies and aspects of awareness of language in an area where there is not, I think, quite so much focus that are necessarily occupate. I hope you'll join us then because there's always something Next in Tech.