US Federal Reserve Chairman Jerome Powell arrives for a press conference after the Monetary Policy Committee meeting on December 18, 2024.
AFP via Getty Images
TThe Federal Reserve yesterday made its third interest rate cut of 2024, a move expected to lower borrowing costs across the economy. But shortly after the announcement, the Dow Jones, S&P and Nasdaq all tumbled on the Fed’s 2025 economic outlook, which indicated it expects only two rate cuts in 2025 due to persistent inflation and other economic factors.
But biotech stocks were hit even harder. For example, the S&P 500 fell 3% yesterday and the Nasdaq fell 3.6%, but the closely watched biotech index XBI fell almost 5%, as did SPBIOS. The Nasdaq biotechnology index fell more than 4.2%.
“Biotech stocks tend to be interest rate sensitive given their ongoing financing needs,” said Niels Peetz-Larsen, partner at asset management firm HighVista Strategies. Forbes.
The news is also a blow to biotech startups. The Fed’s inflation-fighting rate hikes led to declining investment in the sector in 2022 and 2023. Rate cuts this year have led to a slight increase in investment, but that investment is currently “stuck in a vicious cycle” driven more by FOMO than by making innovative plays, Sara Choi, a partner at Wing Ventures, told me Forbes. “That’s why you see so many GLP-1 competitors in the obesity management space right now,” she said.
To break out of this cycle, more IPOs and more mergers and acquisitions are needed, according to Choi. That will bring profits to investors and provide more liquidity, which would “help stabilize the biotech market and be a little less reactive,” she added.
But persistently higher interest rates could hinder this activity, making it harder to nurture new breakthrough startups. “Higher financing costs make it more expensive for startups to fund research and development and sustain their operations, slowing down innovation,” said Pitchbook analyst Kazi Helal.
Higher-than-expected interest rates could have other consequences, Helal said. First, it will likely drive investors to other sectors “with more predictable returns,” making it harder for startups to find funding. They could also slow the merger and acquisition activities of major pharmaceutical companies, “which would reduce exit opportunities for biotech startups and constrain the financing ecosystem as a whole,” he added. (Although this may be somewhat offset by the regulatory environment of the incoming Trump administration, which is expected to have a lighter impact on M&A activity.)
Fewer venture investments in biotechnology do not completely abandon companies; startups can also benefit from ‘biobucks’ deals. These are research collaborations with major pharmaceutical companies that typically involve an upfront payment, plus additional millions as critical research and clinical milestones are reached in the development of a new drug.
Higher than expected rates would also have an impact here, Helal said Forbes. “I think the number of deals could decrease, but the total deal value could remain stable or even increase,” he said. Big pharmaceutical companies are more likely to make biobucks deals with late-stage companies “that have compelling clinical data” than early-stage ones. Startups that enter into such deals can also likely expect terms to be more favorable to the big company, he added.
This shift toward biobucks could also change what startups venture capitalists invest in, Helal added, moving away from startups working on specific drugs and more toward startups that innovate the drug discovery process itself. he said. “They can also focus on taking late-stage clinical companies to successful exits.”
InnovationRx is your weekly digest of healthcare news. To receive it in your inbox every Wednesday, subscribe here.
These are all risks in the current interest rate environment, but there is no guarantee that the Federal Reserve will cut rates at all in 2025. During the transition so far, President-elect Trump has been consistent in his call for tariffs. Yesterday the Congressional Budget Office said in a letter to Congress that Trump’s proposed tariffs would “put upward pressure on inflation” and also “reduce returns on new investments.”
That combination could lead the Federal Reserve to halt interest rate cuts or even raise rates again. A financing environment that tightens even further, Helal says, “could reduce investor confidence and make securing financing particularly challenging for startups, especially those without late-stage assets.”
The bottom line is that in an industry driven by innovation, some of the biggest costs come in the form of missed opportunities. A market environment that pushes investment away from innovation and toward safer, more secure choices means patients miss out on disease treatments that could be delayed for years – if they come to market at all.
MORE AT FORBES