The number of corporate bankruptcies in the U.S. is projected to reach a 13-year high, as the Federal Reserve's escalating interest rates begin to impact businesses, Guggenheim Investments research indicated on Friday. Over 450 companies have sought bankruptcy protection since the beginning of the year, exceeding the annual totals for the previous two years.
Guggenheim's research team, spearheaded by U.S. economist Mike Bush, anticipates that bankruptcy filings will continue at this rate, achieving a peak unseen since 2010. The researchers attribute this trend to several factors, including diminishing support from falling inflation rates, an expanding fiscal deficit, and an absence of widespread layoffs.
The team predicts a slowdown in the U.S economy towards year-end due to these fading economic tailwinds and forecasts a possible recession by early 2024. Corporate defaults typically occur when companies can no longer fulfill their debt obligations and their liquidity evaporates.
The borrowing cost has significantly increased as the Fed has raised its policy rate to between 5.25% and 5.5%, a level not witnessed in 22 years. Despite an expected unchanged rate at its next meeting in September, the central bank is predicted to sustain these high rates for an extended period.
During the pandemic, many corporations capitalized on low interest rates to refinance their debts, providing some relief from the Fed's hikes. However, Guggenheim notes that higher interest rates are not entirely detrimental for businesses. Despite corporations facing borrowing costs of between 5.8% and 8.4% in the corporate bond market, overall interest expenses have reduced due to gains on cash and cash-like investments.
Guggenheim estimates that U.S nonfinancial corporations are earning a record $171 billion in interest income from cash, Treasury, and Agency debt holdings, marking an increase of $102 billion from the previous year. The research team expects companies in high-margin and cash flow industries to exhibit resilience as the economy slows, especially as corporations are in the best position to cover interest payments since 1960.
However, the outlook is less optimistic for companies burdened with debt. BofA Global stated that the U.S. high-yield or "junk" bond market is facing a Fed that is compelled to maintain high rates due to its 2% annual inflation target.
Credit strategist Oleg Melentyev believes that the credit market can withstand a 3% CPI scenario even at current valuations. However, a 4% CPI could result in cumulative defaults reaching 10%, with significant downgrades in the high-risk CCC-ratings category. A rise to 5% CPI could trigger a full-scale wave of defaults.
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