The US economy is showing resilience, but Trust Economics warns that recession is still on the table.
In this context, a warning bell is the increase in corporate bankruptcies and debt defaults that pose a great threat to the economy. At the root of the problem is, of course, the increase in interest rates that negatively affects businesses and consumers, increasing the chances of a recession. According to S&P Global, 516 companies filed for bankruptcy by the end of September.
More bankruptcies this year than in 2021 and 2022 combined
This number already exceeds the total number of bankruptcies recorded in 2021 and 2022 combined. But defaults on US corporate bonds have also risen. This year there were 127 defaults on corporate bonds as of the end of October, according to a separate report by S&P Global, 13% more than the five-year average.
Borrowing costs for some companies doubled or even tripled in 2023 compared to previous years, putting a severe strain on corporate balance sheets. Real yields on non-investment-grade corporate bonds jumped above 9% in October and traded at 8.5% last week, according to the ICE BofA U.S. High Yield Index.
And although bond yields fell slightly in November from October, the yield on the US 10-year Treasury note hit a 16-year high in September, weighing on borrowing costs across the economy. The 10-year yield was trading around 4.42% last week
When companies manage their balance sheets and want to issue or refinance debt, they have to issue debt at significantly higher yields than they’ve had in recent years, and that’s a big hit to their profits. They now have to pay more interest and this can negatively affect their corporate profits in an environment where revenues are growing at a slower rate.
This is particularly difficult for so-called zombie companies, which are companies that do not have cash on hand to service their debt (please also read the analysis titled “Social Tensions and Zombie Companies in the EU“).
Many zombie companies have been able to survive in an extremely low interest rate environment, when borrowing costs were close to zero and companies could continue to refinance their debt with relative ease.
But this has changed to a regime of higher interest rates and appears to be contributing at least in part to the wave of risk generation in the corporate sector.
High-yield bond defaults are expected to reach 4.5%-5% by the end of this year, according to Fitch Ratings, six times the 0.7% default rate recorded among all bond issuers high performance in 2021.
There is a risk of recession
Corporate bankruptcies and defaults on corporate bonds are likely to increase through 2024. In the US, bankruptcies and defaults are expected to peak sometime by the end of the first quarter of 2024.
And this increase in corporate bankruptcies and defaults this year and next is expected to have a very negative effect on the US economy and throw it into recession. Companies struggling with bankruptcy or heavy debt are cutting their workforces as they try to regain financial strength.
These developments are also negative for asset prices, specifically for high-yield bonds and bank loans, which could also negatively affect stock prices. If companies have difficulties, there are negative effects on stock prices. And if you’re an investor and see your assets lose value, you might cut back on your spending. Add to these the twin forces of losses and lower spending and we have a mix that can slow the economy.
But there are other signs that the economy is slowing down. E.g. consumers are starting to use up excess savings built up during the pandemic, students are starting to pay off student loans and this is expected to put pressure on spending while a sharp rise in bond yields is expected to raise borrowing costs across the economy .
