Goldman Sachs Increases Default Forecast for US High-Yield Corporate Bonds
Goldman Sachs has raised its default forecast for US high-yield corporate bonds to 4% from 2.8% this year, amid concerns about the volume of corporate defaults and the tightening of credit conditions. The bank’s economics team warned that stress in the banking sector will tighten credit conditions, with the expected pullback from regional US banks alone equivalent to Fed interest rate hikes of between 25 and 50 basis points. This comes as the volume of junk bonds subject to corporate defaults hit over $11bn in Q1 2023, surpassing the total for the two previous years.
Goldman Sachs’ credit research team recently issued a weekly client note warning that the volume of corporate defaults is increasing and investors are asking what the forward pipeline of defaults looks like from here. Indeed, with over $11bn of junk bonds subject to corporate defaults in the first quarter of this year, the volume has now surpassed the total dollar amount for all of 2021 and 2022. This should concern investors because corporate defaults were rare before the Federal Reserve began raising interest rates last year. In the longer term, the junk-bond sector’s average yearly default rate was 4.3% for the past 25 years, according to Goldman data.
Goldman’s economics team also warned that stress in the banking sector will tighten credit conditions. This is in line with Federal Reserve Chairman Jerome Powell’s comments following another Fed rate hike of 25 basis points, stating that the question is how significant will this credit tightening be and how sustainable it will be.
The tightening credit conditions have been felt throughout the economy, and particularly in the case of leveraged companies. The failure of Signature Bank and Silicon Valley Bank is evidence of this. Distressed bond supply in the US junk-bond market hit about $120bn as of a week ago, according to CreditSights, with almost 100 issuers with debt trading in distressed territory in the days before the two banks defaulted.
Finally, it’s worth noting that U.S. homeowners and many companies snapped up cheap debt during the pandemic to refinance at historically low rates. However, borrowing in both sectors has slowed dramatically in recent months due to the rising interest rates. The Fed has already raised its policy rate to a range of 4.75% to 5% in a year, with a terminal rate range penciled in at 5% to 5.25%. This has hurt banks’ holdings of Treasuries and mortgage bond securities, putting an estimated $620bn of their securities underwater on a mark-to-market basis.
