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Corporate Debt Cliff: Business Defaults Soar in Adverse Rate Environment

Isaac Nuriani    |
Jan 26, 2024
  • Corporate debt defaults jumped 80% in 2023.
  • U.S. business insolvencies projected to rise 22% this year.
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Regular readers of this blog may know that last week I discussed the polycrisis…a potentially challenging condition in which the existence of multiple crises simultaneously results in a larger “super” crisis.

As for the current polycrisis experts say that has been in play for the last couple of years, several of its component crises are readily apparent. According to the U.S. Chamber of Commerce Foundation’s recent report Navigating the Polycrisis, one of those components is persistent inflation, which has been with us for nearly three years.[1]

Another polycrisis component is fiscal uncertainty.[2] America’s fiscal excesses over the last few decades have created a national debt balance now above $34 trillion.[3] What’s more, the pace of borrowing right now in the form of the annual budget deficit is unlike anything we’ve seen before.[4]

Geopolitical uncertainty is yet another component of the polycrisis.[5] No real surprise there, either, given the ongoing stakes of the Russia-Ukraine conflict, the war between Israel and Hamas and the chronically poor – and potentially worsening – relationship between superpowers China and the U.S.[6]

Some components of the polycrisis may not be so immediately apparent, however. One of those is the soaring rate of business insolvencies worldwide…a problem projected to worsen in 2024.[7] According to one estimate, business insolvencies globally will increase by 10% this year, while insolvencies in the U.S. will surge by 22%.[8]

The fragility of businesses both here and abroad is due primarily to two interrelated factors: the enormous debt loads those businesses are lugging around today, and the current climate of higher interest rates. And the challenges posed by a high-debt, high-rate environment for businesses could result in a corporate “debt cliff,” suggest analysts, one from which companies could tumble…bringing the economy down with them.[9]

There already are signs of a potentially powerful momentum gathering toward such an eventuality. According to a new report by S&P Global Ratings, corporate debt defaults soared in 2023, and are poised to worsen in 2024 as multiple pressures continue building on companies – including the persistently unfavorable rate climate.[10]

We’re beginning to see the consequences, as well. U.S. commercial bankruptcy filings were up nearly 20% overall last year, with filings of Chapter 11 (reorganization) up a jaw-dropping 72%.[11] Multinational financial services company Allianz is projecting that persistently higher rates will drive up U.S. business insolvencies in 2024 by 22%.[12]

Some have suggested there is little to fear in the long run, because of the widely anticipated Fed pivot this year from restrictive to accommodative monetary policy. But recent inflation data calls into question just how soon we’ll actually see rate relief, suggesting debt-laden companies might remain in an adversarial rate environment through the foreseeable future.

This week, we’re going to use our binoculars to get a closer look at the corporate debt cliff that’s starting to form…and also try to ascertain to what degree companies – and investors – can count on a change in the rate environment to lower the risks of slipping over the edge.

S&P Global: Corporate Debt Defaults Soared 80% in 2023

A long time ago, in what now seems like another galaxy, money was free.

Well, sort of.

In 2008, as summer was heading into fall and the Federal Reserve was furiously pushing back against both the near- and long-term impacts of the global financial crisis, the central bank – as part of that effort – lowered the federal funds rate below 2% and kept it there for 10 straight years.[13]

There had never been a period like it before in U.S. history: an entire decade during which the nation’s benchmark interest rate not only stayed below 2%, but sat close to zero percent for almost all of that time.[14]

Along with practically everyone else, businesses consumed enormous amounts of debt to survive and even thrive, because at such a low cost for the money…why not?

Just as interest rates were beginning to tick back up toward the end of the 2010s…POW; the global health crisis suddenly emerged in early 2020.

And businesses once again headed to the debt trough.

“In 2020, we had these very unique circumstances where companies didn’t know if the economy would be shut down for another year or how long the Fed’s intervention in the corporate-debt market would last,” said David Mericle, chief U.S. economist at Goldman Sachs, “and they issued a huge amount of debt.”[15]

To say the least. Since 2020, company debt has increased by 18.3% as businesses took advantage of the Fed’s pandemic-generated rate cuts and stocked up on loads of debt.[16] Now, according to the Federal Reserve, corporate debt among U.S. companies totals an enormous $13.7 trillion.[17]

But there’s a problem materializing – and it’s doing so quickly. As all that debt matures, it needs to be rolled over; refinanced, in other words. But debt refinanced in today’s rate climate becomes substantially more expensive than it was when companies first assumed it. And the resulting increase in financial pressure could be more than many companies ultimately can bear.

Signs of these increased pressures are evident already. Worldwide, corporate debt defaults soared by 80% in 2023, according to S&P Global Ratings.[18] Outside of pandemic-plagued 2020, it was the highest calendar-year default rate in seven years.[19]

U.S. Companies Accounted for 63% of All Corporate Defaults in 2023

The 2023 default data was particularly unkind to U.S.-based companies, which accounted for 63% of all defaults globally last year. Additionally, there were 2.6 times the number of defaults in the U.S. last year than there were in 2022.[20]

Through the foreseeable future, the situation for businesses globally could become even more precarious.

“In 2024, we expect further credit deterioration globally, predominantly at the lower end of the rating scale (rated ‘B-’ or below), where close to 40% of issuers are at risk of downgrades,” S&P Global said. “We expect financing costs to remain elevated despite the prospect of rate cuts. And while borrowers have reduced their 2024 maturities, a large share of speculative-grade debt is expected to mature in 2025 and 2026.”[21]

Notably, last year’s default trouble came on the back of $600 billion or so of maturing debt. That figure is projected to rise to nearly $800 billion this year.[22] And, according to Goldman Sachs, it will rise to $1 trillion-plus per year from 2025 to 2028.[23]

Recognizing the formidable financial weight created by compounding those massive debt loads with higher interest rates, S&P Global said, “We…expect the pressures from higher interest rates to become more widespread, straining cash flows–particularly for issuers with higher debt burdens.”[24]

As Thomas Lauria, global head of restructuring at commercial bankruptcy law firm White & Case said recently, “When interest rates are 1 or 2 [percent] you can incur a lot of debt and you can afford the debt service. When they go up to 5, 6, 7, 8, 9, 10, things become more challenging.”[25]

But what of all this talk that interest rates are headed back down? Will not the return to a cycle of declining rates, as is projected in 2024, reduce the slope of the feared corporate debt cliff?

It would. But an imminent pivot back to accommodative monetary policy, although widely forecast, is hardly a certainty. And a look at some of the most recent and highest-profile inflation numbers explains why.

Deutsche Bank: Risk Remains High That a Mild Downturn Could Morph Into a “Deeper Recession”

In a recent report on surging business insolvencies and the broad pressures faced by businesses in the challenging rate climate, Reuters suggested the widely anticipated central-bank pivot to accommodative monetary policy could be the life preserver for a corporate sector drowning in debt.[26]

The Federal Reserve itself seems to think it will enact the equivalent of three quarter-point rate cuts this year.[27] Traders are even more optimistic, betting there’ll be as many as six quarter-point slashes in 2024.[28]

But there’s this: Fed officials have been dutiful and consistent about tempering any suggestions that easier-money policy could be on the way with firm caveats that inflation must continue to cooperate. Published minutes from December’s policy meeting revealed that members of the Federal Open Market Committee “reaffirmed that it would be appropriate for policy to remain at a restrictive stance for some time until inflation was clearly moving down sustainably toward the Committee’s objective” of 2%.[29]

On that note, signs have emerged recently suggesting the path being traveled by inflation back to target (2%) may not be quite as clear now as perhaps it appeared just a handful of months ago.

Case in point: December’s U.S. headline (all items) consumer price index (CPI) increased at a rate of 3.4% year over year, accelerating by three-tenths of a percentage point over the 3.1% pace set in November.[30]

Notable, too, is that inflation’s capacity for accelerating – or reaccelerating – is not limited to the U.S.

The United Kingdom’s consumer price index sped up “unexpectedly” for the first time in 10 months last month, landing at an annual rate of 4% after coming in at 3.9% in November.[31] Annual inflation across the 20-nation Eurozone also moved faster in December, motoring at 2.9%, faster than November’s 2.4%.[32]

Here’s the point: If inflation persists, it seems a safe bet that higher interest rates will persist, as well. And if higher rates persist, so, too, will pressure on companies desperately counting on lower rates at which to refinance their enormous quantities of debt.

“Can lending standards loosen, and can yields fall, quickly enough to avoid a funding accident that could see contagion?” Deutsche Bank analysts David Folkerts-Landau and Jim Reid rhetorically asked recently.[33]

That remains the multi-trillion-dollar question. If the answer is ultimately, “No,” then investors – including retirement savers – could find themselves contending with the potential fallout. Some analysts suggest precious metals – including those eligible for inclusion in a gold IRA – could help play a role in hedging portfolios against the associated impacts.

However one prepares their holdings for the possible consequences of a corporate debt cliff, doing so sooner rather than later may be the most prudent way to go; particularly given the recent declaration by Deutsche Bank analysts Folkerts-Landau and Reid that prevailing “risk that can turn a mild downturn into a deeper recession remains high.”[34]

 

[1] Michael Carney, U.S. Chamber of Commerce Foundation, “Navigating the Polycrisis: Global Risks and Opportunities Lie Ahead in 2024” (January 12, 2024, accessed 1/25/24).
[2] Ibid.
[3] Fatima Hussein and Josh Boak, AP News, “US national debt hits record $34 trillion as Congress gears up for funding fight” (January 2, 2024, accessed 1/25/24).
[4] FiscalData.Treasury.org, “What is the national deficit?” (accessed 1/25/24).
[5] Carney, “Navigating the Polycrisis.”
[6] Scott Kennedy, CSIS.org, “U.S.-China Relations in 2024: Managing Competition without Conflict” (January 3, 2024, accessed 1/25/24).
[7] Carney, “Navigating the Polycrisis”; Allianz, “Global Insolvency Outlook 2023-25: From maul to ruck?” (October 18, 2023, accessed 1/25/24).
[8] Allianz, “Global Insolvency Outlook 2023-25.”
[9] Jeff Cox, CNBC.com, “Corporate debt defaults soared 80% in 2023 and could be high again this year, S&P says” (January 16, 2024, accessed 1/25/24).
[10] Ibid.
[11] Vincent Ryan, CFO.com, “Chapter 11 Bankruptcy Filings Rose 72% in 2023” (January 10, 2024, accessed 1/25/24).
[12] Allianz, “Global Insolvency Outlook 2023-25.”
[13] Federal Reserve Bank of St. Louis, “Federal Funds Effective Rate” (accessed 1/25/24).
[14] Ibid.
[15] Greg Ip et al., Wall Street Journal, “Rates Are Up. We’re Just Starting to Feel the Heat.” (September 1, 2023, accessed 1/25/24).
[16] Cox, “Corporate debt defaults soared 80%.”
[17] FederalReserve.gov, “Financial Accounts of the United States – Z.1” (accessed 1/25/24).
[18] S&P Global, “Default, Transition, and Recovery: Corporate Defaults Jumped 80% In 2023 To 153” (January 16, 2024, accessed 1/25/24).
[19] Cox, “Corporate debt defaults soared 80%.”
[20] S&P Global, “Default, Transition, and Recovery.”
[21] Ibid.
[22] S&P Global, “Global Corporate Debt Maturities Through 2026” (accessed 1/25/24).
[23] Goldman Sachs, “The Corporate Debt Maturity Wall: Implications for Capex and Employment” (August 6, 2023, accessed 1/25/24).
[24] S&P Global, “Default, Transition, and Recovery.”
[25] Harriet Clarfelt, Financial Times, “Can corporate America cope with its vast debt pile?” (November 6, 2023, accessed 1/25/24).
[26] Reuters.com, “US bankruptcies surged 18% in 2023 and seen rising again in 2024 -report” (January 3, 2024, accessed 1/25/24).
[27] FederalReserve.gov, “Summary of Economic Projections” (December 13, 2023, accessed 1/25/24).
[28] CME Group, “FedWatch Tool” (accessed 1/25/24).
[29] Jeff Cox, CNBC.com, “Fed officials in December saw rate cuts likely, but path highly uncertain, minutes show” (January 3, 2024, accessed 1/25/24).
[30] Alicia Wallace, CNN Business, “America’s final inflation report for 2023 just came in” (January 11, 2024, accessed 1/25/24).
[31] Tom Rees and Philip Aldrick, Bloomberg.com, “UK Inflation Rises Unexpectedly, Tempering Talk of Rate Cuts” (January 17, 2024, accessed 1/25/24).
[32] Anna Cooban, CNN Business, “Inflation isn’t beaten yet. Price rises are accelerating again in Europe” (January 5, 2024, accessed 1/25/24).
[33] David Folkerts-Landau and Jim Reid, Deutsche Bank, “Outlook for 2024 – the race against time” (December 7, 2023, accessed 1/25/24).
[34] Ibid.
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