Moody’s Investor Services expects the global speculative-grade corporate default rate to rise in 2023 as slowing economic growth, higher input costs and rising interest rates reduce consumer and business demand, pressure corporate earnings and hamper free cash flow.
“Under our baseline scenario, we expect the default rate to rise to 4.4% at the end of 2023 and to 4.6% by the end of January 2024,” noted the team, in their ‘January 2023 Default Report’. These forecasts, if realised, would surpass the long-term average of 4.1% but remain well below prior recessionary levels, including the pandemic peak of 7%. Our latest forecasts are lower than our projections last month, primarily because of a drop in our high-yield spread assumption as recent levels have been lower than we had previously expected. We now assume the US high-yield spread will widen to only 510 basis points (bps) in the coming 12 months, down from our forecast of 596 bps last month. With regard to the US unemployment rate, we continue to expect it to rise to 5.0% in 12 months from the current rate of 3.4%.” There are potential dynamics which could push the default rate higher than the firm’s expected baseline scenario, including economic and financial risks that may occur, leading the team to develop two scenarios more pessimistic than the baseline perspective, one moderately so and the other severely pessimistic.
The risks include:
(1) Persistently high inflation leads to more aggressive interest rate hikes than anticipated, with liquidity tightening further and growth falling faster and lower;
(2) The Russia-Ukraine military conflict further escalates in a way that poses significant additional risks to the global economy and financial conditions;
(3) Europe’s relative resilience thus far to the energy shock quickly erodes, leading to severely negative economic outcomes;
(4) The reopening of China’s economy does not yield the expected uptick in growth, and the slowdown deepens instead, with negative spillovers to global growth and credit conditions; or
(5) a resurgence of COVID-19 causes widespread economic disruption.
“Under the moderately pessimistic scenario, we forecast that the US high-yield spread would widen to 1,078 bps and the unemployment rate would rise to 7.8%, pushing up the global speculative-grade default rate to 10.4% by January 2024,” they wrote.
“The severely pessimistic scenario assumes even weaker macroeconomic conditions, with a surge in the US high-yield spread to 1,371 bps and a jump in the unemployment rate to 8.5%. Under this scenario, the global speculative-grade default rate would rise to 15.9% by January 2024, exceeding the 13.5% peak during the global financial crisis.”
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