Goldman Sachs this week increased its default forecast for U.S. high-yield, or “junk-rated,” corporate bonds this year to 4% from 2.8% after more companies this year have been buckling under their debts.
The cloudier outlook for junk bonds comes as Wall Street feels the squeeze of tighter credit conditions, while bracing for the economic backdrop to get worse.
With more than $11 billion of junk bonds subject to corporate defaults in the first quarter (see chart), the volume now has surpassed the total dollar amount for all of 2021 and 2022.
U.S. junk-bond defaults in Q1 top last two years combined.
Bloomberg, Goldman Sachs
Corporate defaults were rare before the Federal Reserve started raising interest rates last year. Over the longer term, the junk-bond sector’s average yearly default rate was 4.3% for the past 25 years, according to Goldman data.
Lotfi Karoui’s credit research team at Goldman said, “many investors are asking what the forward pipeline of defaults looks like from here,” in a weekly client note. Concerns have been elevated as corporate defaults jumped to start 2023, with more expected as credit conditions tighten after the failures of Signature Bank
SBNY,
and Silicon Valley Bank.
Distress hits $120 billion
Distressed bond supply in the U.S. junk-bond market hit about $120 billion as of a week ago, according to CreditSights. In the days before the two banks defaulted, there were almost 100 issuers with debt trading in distressed territory, or at a spread of at least 1,000 basis points above Treasury yield, according to CreditSights.
“It’s the speed and magnitude of interest-rate hikes that made parts of the tech sector unviable, and led to the collapse of Silicon Valley Bank,” said Evan DuFaux, a special situations analyst at CreditSights, by phone Friday.
“Those effects will be felt throughout the economy, and particularly in the case of leveraged companies.”
Separately, Goldman’s economics team on Friday said stress in the banking sector will tighten credit conditions, gauging the expected pullback from regional U.S. banks alone as equivalent to Fed interest rate hikes of 25-50 basis points.
That was a theme Federal Reserve Chairman Jerome Powell drilled down on Wednesday in a news conference following another Fed rate hike of 25 basis points on Wednesday. “The question is, how significant will this credit tightening be and how sustainable it will be. That’s the issue,” Powell said on Wednesday.
Like U.S. homeowners, many companies snapped up cheap debt during the pandemic to refinance at historically low rates after the Fed cut rates in March 2020 to nearly zero and held them there for about two years. Borrowing in both sectors has slowed dramatically in recent months.
The Fed has already raised its policy rated to a range of 4.75 to 5% in a year, with a terminal rate range penciled in at 5% to 5.25%.
That has hurt banks’ holdings of Treasurys and mortgage bond securities, putting an estimated $620 billion of their securities underwater on a mark-to-market basis.
Related: ‘This is a risk confronting all banks,’ ex-FDIC chief Sheila Bair tells MarketWatch
U.S. stocks were volatile in the past week, but posted weekly gains. The Dow Jones Industrial Average
DJIA,
advanced 0.4% Friday, the S&P 500 Index
SPX,
rose 0.6% and the Nasdaq Composite Index
COMP,
climbed 0.3%, according to FactSet.
