S&P Global Ratings forecasts that costlier financing from higher rates and weaker corporate earnings will increase the 12-month trailing default rate of non-investment-grade rated companies to 4% by December, up from a historically low 1.7% at the end of 2022. The forecast is predicated on a mild, shallow recession later this year, though a deeper-than-feared downturn and higher interest rates could see that default rate hit 6%.
Markets movements
Investors rushed to the credit default swap market in 2022 as a way to protect against the threat of rising defaults as the Fed raised rates from near-zero to a range of 4.25-4.5% by year-end. Meanwhile, liquidity in bond markets dried up, with issuance collapsing as the cost of corporate borrowing rose sharply. The yield on the S&P U.S. High Yield Corporate Bond Index, for example, climbed from 4.2% at the start of 2022 to 8.76% on March 8, 2023, with an 11-basis-point increase following Powell's comments to Congress.
"It was the news investors didn't want to hear but deep down had a sneaky suspicion would come," said Russ Mould, investment director at AJ Bell. "Powell made it perfectly clear that U.S. interest rates would keep going up, potentially faster and harder than markets had previously priced in."
BBB-rated companies, which account for more than 20% of the companies covered by Ratings, face particular threats from spikes in high-yield borrowing costs as they sit just one notch above that speculative-grade pool. The increase in borrowing costs between investment-grade and high-yield companies can be sharp, owing to the higher perceived risk of the debt and the reduced liquidity in the high-yield space.
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