US corporate debt is $1tr looming tragedy
The weakest link comes to haunt investors as Fed readies a rate hike
There has been growing uneasiness in the US corporate bond market with rising borrowing costs for companies with low ratings as US prepares for the first rate hike after a gap of seven years.
Standard & Poor’s has cut its ratings on US bonds worth $1.04 trillion (Dh3.81 trillion) in the first 11 months of the year, a 72 per cent jump from of 2014 even as upgrades fall. Analysts the various ratings agencies expect default rates to increase over the next 12 months, an inopportune time for Federal Reserve policymakers.
“It is of big concern that we see more downgrades, and possible a rise in default rates. The biggest trigger is if this happens fast and uncontrollable then we could witness larger market impacts,” Simon Fasdal, head of fixed income trading at Saxo Bank told Gulf News.
“It is normally at the end of a credit cycle that we see a higher default rate, the big question is if this rise will be higher than normal, igniting a broad based credit crunch,” Fasdal added.
This plus a free fall in commodity prices including oil, have dented the financial performance of companies, accounting for a third of distressed credits.
More than 100 companies have defaulted since the start of the year with only a few market leaders able to retain the coveted triple A rating.
“The oil and gas and media and entertainment sectors have the highest concentration of weakest links with three issuers each out of seven,” the S&P said in a report.
The risk is deep with analysts betting that it may impact the banking system.
“In 2016 the probability of a credit event has clearly increased, that should worry investors as it would probably infect the banking system. High yield bonds indexes are pricing a high level of defaults to come in the energy sector in the next five years,” Jean-sylvain Perrig, senior managing director and head of asset allocation and chief investment officer, private banking with Union Bancaire Privee told Gulf News.
Investor flows
The credit worries have started to manifest themselves in investor flows.
While flows into junk bond funds remain positive for the year, managers of both exchange traded funds (ETFs) and mutual funds have been hit by outflows of roughly $3.3 billion over the past four weeks, according to data from Lipper.
In the wake of a stellar October, State Street’s high-yield bond ETF — known by its stock market ticker JNK — has suffered outflows of $773 million over the past four weeks. BlackRock’s popular junk ETF, known as HYG, has seen withdrawals of roughly $76 million over the same period.
“If the banking system is impacted, you would see a rise of systemic risk and in such circumstances most financial asset correlate and go down,” Perrig said.