Rising interest rates are expected to lead to a surge in corporate defaults, warns Janus Henderson Investors.
Their latest ‘Credit Risk Monitor’ reveals that key indicators – cashflow and earnings, debt loads and servicing and access to capital markets – have been red for over a year, signalling a downward trend in the credit cycle.
As inflation falls and the economy shifts from supply-led to demand-led deflation, borrowing costs could significantly outpace revenue growth, warned Janus Henderson Investors, increasing risk for corporate credit investors. Opportunities exist, but careful credit selection is crucial, it added.
The report notes that while large-cap companies are expected to continue refinancing with ease, small and medium enterprises will likely struggle to borrow.
The real cost of borrowing is the highest it has been in nearly a decade, significantly impacting companies, particularly if revenues slow down.
In terms of asset allocation, careful selection is vital, said Janus Henderson Investors. Corporate spreads do not fully reflect global economic risks, it added, while defensive sectors in the bond market, like investment-grade credit, are expected to offer attractive total returns and strong diversification benefits.
Jim Cielinski, global head of fixed income, added: “This is a time in the cycle to focus on the difference between total returns and excess returns. Interest rates have skyrocketed, producing some of the highest levels of yield in more than a decade.
“Only 18 months ago, central banks were indiscriminate buyers of bonds, but have now become price-insensitive sellers. Budget deficits are ballooning, hitting 7% of GDP in the US. The supply-demand rebalance is catching investors off guard as they view these fiscal trends as unsustainable. Bond investors are demanding additional compensation.”
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