The Fed’s Warnings On Inflation Are Bad News For Biotech Startups

The Federal Reserve rolled out its third interest rate cut of 2024 yesterday, a move expected to lower borrowing costs across the economy. But shortly after the announcement, the Dow, S&P and Nasdaq all plummeted due to the Fed’s economic outlook for 2025, which indicated it only expects two rate cuts in 2025 because of stubbornly persistent inflation and other economic factors.

But biotech stocks were hit even harder. For example, the S&P 500 dropped 3% yesterday and the Nasdaq 3.6%, but closely watched biotech index XBI was down nearly 5%, as was SPBIOS. The Nasdaq biotechnology index was down over 4.2%.

“Biotech stocks tend to be interest rate sensitive given their ongoing funding needs,” Niels Peetz-Larsen, partner at asset-management firm HighVista Strategies told Forbes.

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The news is a blow to biotech startups as well. The Fed’s inflation-fighting rate hikes led to declining investments in the sector in 2022 and 2023. Rate cuts this year have led to a slight increase in investment, but those investments are currently “stuck in a vicious cycle” driven more by FOMO than by making innovative plays, Sara Choi, a partner at Wing Ventures, told Forbes. “That’s why you see so many GLP-1 competitors in obesity management right now,” she said.

Getting out of this cycle, Choi said, will take more IPOs and more M&A. That will give investors wins and provide more liquidity, which would “help the biotech market stabilize and be a little bit less reactive,” she added.

But persistently higher interest rates could hinder this activity, making it harder to nurture new breakthrough startups. “Increased borrowing costs makes it more expensive for startups to fund research and development and maintain operations, thereby slowing down innovation,“ according to Pitchbook analyst Kazi Helal.

Higher than expected interest rates could have other implications, Helal said. For one, it’s likely to drive investors into other sectors “with more predictable returns,” making it harder for startups to find funding. They could also slow down M&A activity from big pharma companies, “reducing exit opportunities for biotech startups and limiting the funding ecosystem as a whole,” he added. (Though this may be somewhat balanced out by the regulatory environment of the incoming Trump administration, which is expected to have a lighter touch on M&A.)

Fewer venture investments in biotech doesn’t leave companies completely in the lurch–startups can also take advantage of “biobucks” deals. These are research collaborations with big pharmaceutical companies that typically involve an upfront payment, plus additional millions as crucial research and clinical milestones are met in the development of a new drug.

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Here, too, higher than expected rates would have an impact, Helal told Forbes. “I think the number of deals may decrease but the total deal value could remain stable or even increase,” he said. Big pharma companies will be more inclined to make biobucks deals with late-stage companies “that have compelling clinical data” than early-stage startups. Startups that enter those deals can also likely expect the 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 towards those innovating the drug discovery process itself. he said. “They may also concentrate on advancing late-stage clinical companies to successful exits.”

These are all risks in the current interest environment, but there’s no guarantee that the Federal Reserve will cut rates at all in 2025. Through 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 rate cuts or even bring interest rates back up again. A funding environment that tightens even further, Helal said, “can diminish investor confidence and make securing funding 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 lost opportunities. A market environment that drives investment away from innovation and towards safer, surer bets, means patients lose out on disease treatments that might be delayed for years–if they even make it to the market at all.

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