Consumers aren’t the only ones defaulting on their debts: Corporate bond defaults were up massively in 2023, especially for high-risk junk debt, and the trend is continuing this year at a pace not seen since the 2008 global financial crisis. Unsurprisingly, companies selling low-rated junk debt are being hit the worst.
Last year, according to S&P Global Ratings, corporate bond defaults increased by a disconcerting 80%. High interest rates coupled with high inflation have made it a struggle for companies to make good on their commitments even as waves of new bond buyers continue to arrive, eager to lock in higher yields before rates go down. Demand remains strong for junk bonds and hybrid debt, but for companies with poor liquidity, poor to negative cash flow, and/or an outsized existing debt burden, the result is a compelling setup for even more defaults in 2024.
For now, with rate cuts on the horizon, interest remains strong in junk bond debt even as effective yields have fallen from their 2023 highs, and yield spreads remain relatively low:
Junk Bond Effective Yields, Summer 2022 to Now
Meanwhile, debts that were financed in a low-interest rate environment are due to mature in the next few years, to the tune of over $1.8 trillion by 2028 according to the Fed. When those payments come due, more companies will fall to the default wave. And if the junk bond market goes off of a cliff, it could pop the broader $13.7 trillion corporate bond bubble and take the rest of the economy with it.
Even Bank of America is calling the overheated bond market “bubbly.” With no sign of a short-term slowdown in bond sales, the pressure on premiums is expected to keep increasing for high-risk debt as borrowers rush to fill the demand for high-yield offerings before the Fed cuts rates.
However, as quoted in Bloomberg, Band of America strategists said:
“The unusually supportive technicals currently are unlikely to be sustainable in the longer term.”
Last month, Moody’s changed their rating methodology to align with Fitch and S&P’s rules, making hybrid debt more attractive to overstretched companies in sectors like media, tech, and others. The rule change lets companies take on more hybrid debt to raise money without taking as much of a potential hit to their creditworthiness. As far as the next wave of defaults goes, Moody’s itself reported earlier this year that about 16% of speculative-grade companies are at high risk of defaulting on their obligations, including healthcare companies and airlines:
“Names added to the list last quarter include radio platform iHeart Communications and Spirit Airlines (SAVE.N), whose proposed merger with peer JetBlue (JBLU.O), was blocked on Tuesday…At the same time, as defaults have risen, the ratio of Moody’s downgrades to upgrades among speculative-grade companies grew to 1.8x in the fourth quarter of 2023, up from 1.3x in the previous quarter.”
The Fed hopes that its interest rate cuts will decrease the burden on indebted companies, but it will come at the cost of adding fuel to inflationary pressures that the higher-interest rate environment has failed to contain. Besides, a decrease in interest rates won’t be enough for many low-rated companies to successfully refinance their obligations or take on additional debt. If investors keep flocking to them in search of higher yield compared to Treasurys, that only makes a frothy market even frothier.
Either way, when the entire economy is addicted to an artificially low interest rate environment, the Fed constantly backs itself into a corner and turns to its only real policy tool: printing money. Feverish bond-buying inspired, in part, by artificially-induced interest rate changes is just one of the endless ways that the Fed’s meddling creates a zombie economy. This banker-run fantasyland acts not upon the laws of nature or the principles of sound economics, but the hubris-fueled whims of central bankers who eagerly play the roles of both pseudo-wizard and pseudo-scientist at the dire expense of the governed.
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