Apollo Global Management (NYSE:)’s chief economist, Torsten Slok, warned on Wednesday that the ongoing surge in corporate defaults could intensify if the Federal Reserve maintains elevated interest rates until 2024. This cautionary note was part of his team’s monthly financial forecast. The cost of capital, particularly for firms with weaker credit standing, is becoming burdensome due to consecutive rate hikes implemented by the Federal Reserve.
Historical data shows that default rates for U.S. speculative-grade or “junk-rated” companies are nearing 4%, despite significant economic fallout from the COVID-19 pandemic which already led to numerous defaults among weaker firms. This trend is also being observed among companies that took out leveraged loans during periods of low-cost debt, as floating-rate loans are readjusted upwards in line with rate increases.
The yield on investment-grade bonds has risen to around 5.8%, while the yield on junk bonds is closer to 8.4%. These figures mark a considerable increase from the 20-year lows experienced during the pandemic. The rise in corporate bond yields is largely attributed to an increase in the 10-year Treasury rate, which stood at 4.33% on Wednesday, near a 16-year peak.
Despite these figures, Slok does not believe that current credit spreads indicate an impending recession. If a recession does occur and spreads widen, low spreads could offer opportunities for investors in the U.S.’s approximate $9 trillion corporate bond market, which is mainly comprised of investment-grade rated bonds with relatively low default probabilities.
Retail investor activity appears to have increased compared to 2019 levels according to Apollo’s data, on top of the exposure individuals typically have through pension or retirement accounts. Exchange-traded funds (ETFs) such as the iShares iBoxx $ Investment Grade Corporate Bond ETF and iShares iBoxx $ High Yield Corporate Bond are common vehicles for individuals to invest in the corporate bond market.
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