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.