The U.S. Corporate default rate should rise by 30% and reach 5.6% by June next year according to the Standard & Poor credit rating company – S&P Global Fixed Income Research. Falling oil prices is the main cause of this. It is because of falling oil prices that the 99 lowest credit-rating U.S. firms may possibly have defaulted from July 2016 to June 2017.
This figure is higher than the number of defaults for the previous year to June of this year. 79 companies defaulted in the year to June 2016, which represented a default rate of 4.3%. Much of this comes from the energy sector, which has been responsible for 57% of the defaults over the last period.
This forecast by S&P differs significantly from the confidence of Wall Street – the stock markets expected something very different. Stock market bullishness shows in the falling spread on bonds where investors are expressing confidence in the more speculative bonds in the expectation of a high yield. The companies with lowest credit rating yields differed from those with the highest rating by just 5.6 percentage points. That compares with 8.15 points difference in February.
Tight supply is one of the major reasons for speculative bond prices strengthening. Sales of speculative-grade new bonds this year are down 22% on last year with only $171.8 billion worth sold. They are also a third less than the average issuance since 2013.
Defaults will rise in spite of a failure of the Fed to increase short-term interest rates. This should assist in preventing corporate borrowing costs increasing bonds while investors tend to look for more speculative-grade bonds.
Another boost for U.S. investors is the UK’s decision to exit the European Union. The so-called Brexit vote tends to make European bonds appear a more risky investment that those of the U.S. It should be stressed, however, that the UK will remain a member of the EU for at least the next two years pending an exit agreement. The Brexit effect on the United Stated corporate default rate is unknown, but may change as the UK gets closer to exiting the European Union.
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