19 July 2023
In the midst of a mounting wave of corporate bankruptcies, fears are deepening on Wall Street as the global economy teeters on the brink of deflation. The surge in corporate debt distress, which has already surpassed $500 billion, threatens to impede economic growth and strain credit markets that are still recovering from historic losses.
This distressing scenario is fueled by the weight of soaring debt levels accumulated during a period of unprecedentedly low interest rates. Central banks, caught off guard by surging inflation, are deliberately tightening monetary policy to slow down economies and restrict credit flow, resulting in an inevitable wave of business failures.
The vulnerability is particularly acute in sectors burdened by excessive debt, as companies struggle to cope with ballooning obligations. In the US, high-yield bonds and leveraged loans more than doubled to $3 trillion since 2008, before the Federal Reserve embarked on aggressive rate hikes. Non-financial Chinese companies also grapple with surging debt relative to the size of their economy, while Europe witnessed a substantial increase in junk-bond sales.
With the cooling growth in China and Europe, along with expectations of continued rate hikes by the Federal Reserve, many businesses may find themselves unable to meet their repayment obligations. The Americas alone have already witnessed a staggering 360% surge in troubled bonds and loans since 2021. If this trend continues to spread, it could trigger the first widespread cycle of defaults since the Great Financial Crisis.
The repercussions of this impending crisis are already apparent, with over 120 major bankruptcies in the US this year alone. Yet, distressingly, less than 15% of the nearly $600 billion of globally distressed debt has actually defaulted thus far, leaving a staggering amount of debt at risk of non-payment or significant struggles.
Moody’s Investors Service predicts that the default rate for speculative-grade companies worldwide is expected to rise to 5.1% next year, with a worst-case scenario surpassing the levels seen during the 2008-2009 credit crash.
While the resilience of the US economy and signs of inflation slowdown offer some hope, even a modest increase in defaults would pose further challenges. Heightened defaults could trigger a reduction in lending by investors and banks, exacerbating financial distress for more companies as financing options vanish. The resulting bankruptcies would lead to job losses, putting additional pressure on the labor market and dampening consumer spending.