Rising Interest Rates and Inflation Lead to Increase in Corporate Default Rates: What to Expect

The Federal Reserve’s efforts to combat inflation by raising interest rates may lead to an increase in corporate default rates in the coming months. This poses significant challenges for U.S. companies, which are already struggling with higher interest rates that make it more costly to refinance debt, coupled with an uncertain economic outlook.

Moody’s Investors Service has reported 41 defaults in the U.S. and one in Canada so far this year, the highest number globally and more than double the same period in 2022. This underscores the growing challenges faced by companies today.

Fed Chairman Jerome Powell has emphasized that interest rates are expected to rise further this year, albeit at a slower pace, until there is progress in lowering inflation. Bankers and analysts attribute high interest rates as the main cause of distress in the corporate sector. Companies in need of increased liquidity or those with high debt loads requiring refinancing are faced with the high cost of obtaining new debt.

In such circumstances, distressed exchanges or even restructuring, in or out of court, become viable options. However, the rising cost of debt has significantly impacted the cost of capital, making it much more expensive for companies. Companies with greater financial stability may also face obstacles in refinancing due to high interest rates.

Data from S&P Global Market Intelligence shows that through June 22, there were 324 bankruptcy filings, not far behind the total of 374 in 2022. This demonstrates a significant surge in bankruptcy filings recently.

Moody’s projects a rise in the global default rate to 4.6% by the end of the year, higher than the long-term average of 4.1%. Additionally, the rate is expected to increase to 5% by April 2024 before easing.

The risks faced by companies at present include weakening economic growth, high interest rates, and high inflation. Cyclical sectors such as durable consumer goods are particularly vulnerable to cutbacks in consumer spending.

In conclusion, the Federal Reserve’s plan to continue hiking interest rates to address inflation has contributed to an increase in corporate default rates. This trend is likely to persist in the coming months, affecting companies across various sectors. High interest rates and their subsequent impact on the cost of debt have become key contributors to distress in the corporate sector. As a result, bankruptcy filings have risen significantly, prompting companies to consider distressed exchanges or restructuring. The default rate is expected to rise before eventually easing, posing challenges to companies with heavy debt loads and limited access to liquidity.

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