Guggenheim Investments predicts that corporate bankruptcies will reach their highest level in 13 years due to the Federal Reserve’s interest rate hikes. As of the end of August, over 450 corporations have already filed for bankruptcy protection this year, surpassing the annual totals for the past two years. Guggenheim’s macroeconomic and research team expects this year’s filings to be the highest since 2010.
Corporate bankruptcies are on pace for worst year since 2010.
Guggenheim Investments, S&P Global Market Intelligence
Guggenheim’s team, led by U.S. economist Mike Bush, believes that a rebound in the U.S. economy is unlikely. They note that key factors supporting the economy, such as rapidly declining inflation, a growing fiscal deficit, and a lack of widespread layoffs, are starting to fade. The team predicts that the economy will slow down by the end of the year, and they anticipate a recession by early 2024.
When debts come due and liquidity runs out, companies often default. Since the Federal Reserve began significantly increasing its policy rate to the current range of 5.25% to 5.5%, borrowing costs have risen. Many corporations took advantage of ultra-low interest rates during the pandemic to refinance their debts, providing some cushion from the Fed’s rate hikes. Although the central bank is expected to leave its rate unchanged at its upcoming September meeting, it is anticipated to keep rates high for a prolonged period.
See: U.S. economy is trending in the Fed’s direction, so expect Powell to tread carefully next week
Cash to the rescue
Higher rates don’t affect all companies negatively. Guggenheim reports that overall interest expenses have actually decreased for corporations due to the gains made on cash and cash-like investments. The team estimates that U.S. nonfinancial corporates are earning a record $171 billion in interest income from cash, Treasury, and Agency debt holdings, an increase of $102 billion from last year.
In other words, while heavily indebted companies may face difficulties in the coming months, Guggenheim expects “high-margin and cash flow industries” to remain resilient as the economy slows down. These companies are in the best position to cover interest payments since 1960.
However, the outlook for debt-laden companies appears more precarious. BofA Global recently stated that the U.S. high-yield bond market, often referred to as the “junk” bond market, will face extended higher rates as the Federal Reserve aims for a 2% annual inflation target.
According to Oleg Melentyev, credit strategist at BofA Global, the credit market could handle a 3% consumer-price index (CPI) scenario even at current stretched valuations. However, a 4% CPI reading could result in cumulative defaults reaching 10% and “meaningful” downgrades in the high-risk CCC-ratings category. Melentyev warned that a re-acceleration to a 5% CPI could trigger a wave of defaults.
On Friday, stocks closed lower as the United Auto Workers union initiated a strike to demand wage increases from the Big Three automakers. According to FactSet, the Dow Jones Industrial Average
ended the week with a 0.1% gain, while the S&P 500 index
dropped 0.2% and the Nasdaq Composite Index
fell 0.4% since Monday.
See: UAW strike: Ford, GM, Stellantis record profits haven’t been shared fairly with workers, Biden says
