If Hollywood decided to make a movie based on one of Aesop’s fables, “The Boy Who Cried Wolf,” it could easily cast Jerome Powell in the lead role.
Once again, the markets overlooked the Fed Chairman’s remarks about the possibility of raising interest rates, instead focusing on rate cuts.
As a result, stock indices such as S&P 500 and Nasdaq Composite turned green and ten-year government bond yields fell below 4.7%. It seems that everyone is finally convinced that the rate hike cycle has ended.
But why does no one seem to think about the risks of maintaining a restrictive monetary policy for a prolonged period? What about the threat of new bankruptcies and defaults?
For instance, 2022 saw 16 billion-dollar business failures, and 2023 has already surpassed that number, with a 30% increase in overall business failures.
And it could get worse
Bank of America has warned that distressed debt worth an estimated $14 billion is emerging in the technology, media and telecommunications sectors, $13 billion in the healthcare sector and $8 billion in the cable sector.
According to the analysts, “of the $30 billion of impaired face value of USD high-yield debt over the past 12 months, we expect the pace to increase 1.5 times, to $46 billion, over the next year, translating into a default rate of 3.4%.”
Fitch Ratings, meanwhile, estimates that the default rate on high-yield bonds could range between 4.5% and 5% by the end of this year. Meanwhile, total U.S. bankruptcies and debt defaults could peak in the first quarter 2024.
The Federal Reserve’s work will leave its mark
A significant cause for concern is that some companies’ borrowing costs have doubled or nearly tripled by 2023 compared to previous years, putting a heavy burden on corporate balance sheets, Charles Schwab notes.
The gradual reduction in household savings that built up during the pandemic, coupled with the resumption of student loan repayments, is expected to put pressure on consumer spending, which could spell further trouble for businesses.
To be sure, signs that weakening consumer demand is constraining corporate capacity are already evident in sales data, which have been the bleakest in four years.
With over 80% of S&P 500 companies reporting, less than half have beaten revenue estimates for the third quarter. The pace of sales growth has also slowed.
Fewer people pay on time
Another troubling sign is that in the second quarter of 2023, 5.08% of credit card balances went into serious delinquency or were at least 90 days past due.
With credit card debt exceeding $1 trillion in the second quarter, if economic conditions worsen and unemployment rises, problem debts will increase.
Final remarks
All things considered, it is still premature to speak of a promising future, even with the conclusion of monetary policy tightening as long as the threat of a crisis persists.
In this regard, Moody’s, the last bastion of the highest U.S. credit rating (AAA), may re-evaluate its stance, following the example of its counterparts at Fitch.
