The automotive industry experienced extraordinarily high levels of deal activity in 2015. Mergers and acquisitions (M&A) in the sector are expected to remain strong in 2016, but deal volume and frequency may slightly taper off. Below is a summary of four key factors affecting automotive M&A activity, including increasing interest rates and international activity.

Favorable Conditions Exist for Automotive M&A

The last several years, including 2015, presented ideal conditions for dealmaking. Suppliers came out of the recession with strong balance sheets after years of cutting costs and were eager to deploy their cash reserves in acquisitions to achieve growth and meet increased capacity demands. During the first six months of 2015, the automotive industry recorded 276 deals globally and over $34 billion in total aggregate disclosed value according to data reported by PricewaterhouseCoopers (PwC). The automotive industry has been highly profitable over the past five years and KPMG forecasts that global light vehicle sales will increase at a compound annual growth rate of 4.3 percent over the next five years, as additional buyers come into the market.

A number of factors provide an outlook for the North American automotive industry, and related M&A activity, during 2016 that is bullish:

• Automakers continue to make technological advancements related to autonomous driving, collision avoidance, and in-vehicle connectivity

• Cheap fuel prices have renewed consumers’ love for trucks and SUVs

• Unemployment rates have fallen and general economic conditions continue to improve, boosting consumer confidence

According to Ernst & Young’s November 2015 Automotive Capital Confidence Barometer survey, 97 percent of automotive companies reported that they expect to close at least the same number of deals over the 12-month period (ending in November 2016) as they did in the previous 12-month period. Despite the strong deal sentiment, maintaining 2015’s remarkable level of deal activity in 2016 will be challenging.

Will China Continue to Be a Player in Cross-Border Deals?

A substantial degree of cross-border M&A is expected this year and Chinese companies have started making significant investments in the United States. For instance, last year Yanfeng Automotive Trim Systems entered into a joint venture with Johnson Controls forming Yanfeng Automotive Interiors. The joint venture company acquired the automotive interiors unit of Johnson Controls and instantly became the world’s largest manufacturer of automotive interiors, in which China-based Yanfeng holds a 70 percent stake.

The recent economic downturn in China does, however, raise questions regarding its continued involvement in near term cross-border transactions. Pervasive weakness in output, sales revenue, and profitability may thwart Chinese firms’ ability to execute deals. Nonetheless, the reports of China’s economic decline might be overestimated. The Chinese government is expected to proceed with stimulus measures to help stabilize the economy and has adopted an initiative called “Made in China 2025,” an ambitious program that focuses on innovation-driven manufacturing, quality and optimization. The economic downturn could, in fact, spark Chinese companies to more zealously pursue opportunities in other global markets, and acquiring a U.S. company may help advance Chinese firms’ progress in meeting the objectives of the initiative.

Fed Expected to Keep Increasing Rates

A vital factor—and likely the single most important factor—contributing to the unprecedented levels of dealmaking in 2015 was cheap money. The Federal Reserve had maintained near-zero interest rates for about seven years until it raised rates in December 2015. With the U.S. unemployment rate now at a low 5 percent, the Federal Reserve is expected to continue making gradual rate increases throughout 2016, which will likely slow down the overall pace of dealmaking.

Private Equity Firms May Pursue Deals at a Slower Pace

Given the attractive growth prospects for the automotive industry over the next five years, private equity firms will continue investing in the industry. However, they will likely begin scaling back their acquisitions and harvesting some of their existing investments for a couple reasons. First, the Federal Reserve’s interest rate increase will affect private equity buyers who often rely on debt financing to fund acquisitions. Second, EBITDA (earnings before interest, taxes, depreciation, and amortization) multiples in reported transactions have skyrocketed, and it is expected that the availability of attractive suppliers for purchase at a reasonable price will be more limited in 2016.