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The Fed Doesn't Know What Corporate America Needs

Second, it is crucial to understand the non-residential investment process. Our recent survey found that the average hurdle rate for new investments was 13.5%. That is, firms will not even consider investments unless they have projected returns of at least 13.5% a year. Note that this is sharply higher than their after-tax financing costs (a blend of debt and equity financing costs, which is probably closer to 6% today).

Even the projects that are promising 13.5% returns are not automatically selected. We asked the CFOs about the probability of taking on a project that "fits" company strategy (management time and financing would be available). The CFOs said there was only a 33.2% chance the project would be approved in today's environment.

Given this huge contingency buffer between cost of financing and expected cash flows, it is hard to fathom how fine-tuning the interest rate by a few basis points will spur growth. Indeed, we asked the contra-question: suppose your firm just approved an investment project that exceeded the hurdle rate, but unexpectedly, interest rates increased by 1 percentage point (think of the Baa yield going from 4.8% to 5.8%). What is the chance that you would abandon or delay that approved project?

Only a trivial number of CFOs (3.4%) would reconsider their investment. To be clear, a 100 basis point increase in rates would be massive compared to the most optimistic impact of a further QE. Here lies a fundamental disconnect: The Fed thinks that making small changes in interest rates will drive investment growth. Corporate America operates differently. They build in large contingencies before they make investments.

There is no doubt that if firms pursued all the 13.5% projects, this would drive substantial growth -- but they are not. There is an extraordinary amount of uncertainty due to a number of known unknowns: a slow-moving train wreck in Europe, stubbornly high unemployment in the U.S., four years of trillion-dollar fiscal deficits, Iran and other Mideast hotspots, the stalling of the Chinese growth engine, and the U.S. election.

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