US Corporate Bankruptcies Surge as Rising Interest Rates Impact Businesses
The number of corporate bankruptcies in the United States is set to reach a 13-year high, as the Federal Reserve’s escalating interest rates begin to take a toll on businesses, according to research conducted by Guggenheim Investments. Since the beginning of this year, more than 450 companies have sought bankruptcy protection, surpassing the annual totals of the past two years.
Guggenheim’s economists, led by Mike Bush, predict that bankruptcy filings will continue at this accelerated rate, reaching a peak unseen since 2010. Several factors contribute to this trend, including diminishing support from falling inflation rates, an expanding fiscal deficit, and a lack of widespread layoffs.
As these economic tailwinds fade, Guggenheim’s research team anticipates a slowdown in the US economy by the end of the year, possibly leading to a recession by early 2024. Typically, corporate defaults occur when companies can no longer meet their debt obligations and face a liquidity crisis.
The cost of borrowing has significantly increased due to the Federal Reserve’s policy rate hikes, which have brought rates to a level not seen in 22 years, ranging between 5.25% and 5.5%. Although the central bank is expected to keep rates unchanged at its next meeting in September, it is projected to maintain these high rates for an extended period.
During the pandemic, many corporations took advantage of low interest rates to refinance their debts, providing some relief from the Federal Reserve’s hikes. However, Guggenheim highlights that higher interest rates are not entirely detrimental to businesses. Despite facing borrowing costs ranging from 5.8% to 8.4% in the corporate bond market, overall interest expenses have decreased thanks to gains on cash and cash-like investments.
According to Guggenheim’s estimates, nonfinancial corporations in the US are earning a record $171 billion in interest income from their holdings of cash, Treasury, and Agency debt. This reflects an increase of $102 billion from the previous year. The research team expects companies in high-margin and cash flow industries to demonstrate resilience as the economy slows down, especially considering that corporations are in the best position to cover interest payments since 1960.
However, the outlook is less optimistic for heavily indebted companies. BofA Global warns that the US high-yield or junk bond market faces the challenge of a Federal Reserve that is compelled to maintain high rates due to its 2% annual inflation target.
Credit strategist Oleg Melentyev believes that the credit market can withstand a 3% Consumer Price Index (CPI) scenario, even at current valuations. However, a 4% CPI could result in cumulative defaults reaching 10%, along with significant downgrades in the high-risk CCC-ratings category. If the CPI rises to 5%, it could trigger a full-scale wave of defaults.
The increasing number of corporate bankruptcies in the US is a clear sign that rising interest rates are taking a toll on businesses. While some industries may weather the storm due to their strong cash flows, companies burdened with debt face a more challenging road ahead. The Federal Reserve’s commitment to maintaining high rates to combat inflation further compounds the situation, adding to the risks faced by businesses. As the US economy slows down, it becomes crucial for companies to carefully manage their debt obligations and liquidity to avoid becoming victims of this disturbing trend.