Weaker U.S. economy threatens to swell mountain of corporate debt

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Slowing economic growth in the United States and an expected increase in borrowing costs could make American businesses vulnerable after interfering with debt during the pandemic.

Recent data on employment and inflation in the United States show signs of a slowing economic recovery, which could lead to lower business incomes. The Federal Reserve is also preparing to tighten its ultra-accommodative monetary policy in the coming months, which could lead to higher borrowing costs. Both threats could erode companies’ ability to invest in growth and make interest payments as corporate debt levels continue to rise, economists and analysts have said.

“The record level of corporate debt leverage is a major concern as it is largely a speculative note and it is still a bumpy road to recovery for some sectors,” said Nicole Serino, associate director of credit markets research at S&P Global Ratings, said in an email.

Corporate debt could become “unbearable” for the companies that carry them if the revenue recovery starts to falter, Ratings warned.

Borrow to survive

Companies rushed into the bond market in early 2020 to take advantage of low borrowing costs, bringing debt held by non-financial corporations to $ 11.170 billion, an increase of $ 1 trillion during the pandemic, according to the Federal Reserve. The total climbed to over 55% of U.S. GDP in 2020 and remains above pre-pandemic levels.

Rated U.S. companies issued $ 2,122 billion in bonds in 2020 to offset the pandemic-induced shortfall, according to LCD. The record annual total rose 59.7% from 2019. Companies continued to issue bonds at historically high levels in 2021, reaching $ 1.417 trillion as of September 15.

This build-up of debt has left companies well-capitalized, contributing to growth in mergers and acquisitions, capital spending, and share buyback and dividend spending in 2021.

Meanwhile, corporate defaults are hitting new lows. The US 12-month default rate among unrated investment grade companies fell to 3.8% in June, from a peak of 6.7% in December 2020. Ratings predict the rate will fall to 2.5% by June 2022.

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Massive purchases of Treasuries by the Federal Reserve supported corporate bonds as investors were driven out of the government bond market. But with rising inflation and the economy recovering, the Fed plans to cut its asset purchase program by $ 120 billion per month this year, which could reduce demand for US bonds. companies and drive up yields, thereby increasing the cost of borrowing.

“There is a good chance that they will announce [tapering] as early as November, “said Tiffany Wilding, US economist with asset management group PIMCO, in an email.

Debt is rising, economic growth is weakening

Investors’ willingness to continue supporting businesses is not unlimited, but so far they don’t appear to be bothered by the build-up of debt, experts say.

“It is clear that there is a time when credit investors will turn into credit vigilantes if companies become too greedy for credit. [their] use of credit, but we believe this is far from the case for investment grade land, ”Frank Rybinski, director of macro strategy at Aegon Asset Management, said in an email.

While in 2020 companies issued debt to cover lost income, in 2021 they took advantage of low borrowing costs to refinance debt and push back maturities. Non-financial corporations reduced the amount of debt maturing over the 18-month period from July 2021 to the end of 2022 by 21% to $ 779 billion, according to Ratings.

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But by kicking the box, companies risk driving up the amount of non-financial rated debt quickly, from $ 570.0 billion in 2022 to a peak of $ 968.5 billion in 2025.

Meanwhile, signs of a slowing recovery are emerging. High inflation and weak employment data led PIMCO to lower its forecast for US GDP growth for the third quarter to 3% quarter-over-quarter, from 6.5% previously.

Core consumer price inflation – which excludes food and energy prices – rose 4% year-on-year in August, reducing household purchasing power. Job growth in the United States was also disappointing in August, with only 235,000 jobs created compared to an expected 750,000.

According to Adam Slater, senior economist at Oxford Economics, a growth slump would pose a significant challenge to the profit potential of US companies. And an inflation-linked rise in lending rates would make it harder for companies to meet repayments.

“A move to a higher inflation regime only has a 10-15% probability, but even a fairly moderate rise in real interest rates could be a problem,” Slater wrote in a research note. August 31.

COVID-19 cases are also increasing as the delta variant spreads. The Centers for Disease Control and Prevention recorded more than 163,000 new cases of the coronavirus daily on September 15, up from less than 10,000 in mid-June.

The extent of the economic downturn will determine the extent of investor concerns. If growth slows towards the long-term trend, then there will be no significant credit revaluation, said Aegon’s Rybinski.

“If the downturn looks like a recession, then the credit risk increases sharply and with it the premium needed to offset the increased credit risk,” Rybinski said.

LCD is an offering of S&P Global Market Intelligence.

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