Fixed Income  

Bond analysts fear default contagion

Bond analysts fear default contagion

Fixed income analysts have warned of the growing risk of contagion as corporate defaults hit a seven-year high.

Year-to-date defaults are at their highest point since 2009, while April saw the highest number of corporate defaults in any single month since the financial crisis, according to Newton Investment Management.

While the oil and mining sectors have borne most of this pain, the upward trajectory has raised the question of a spillover into other areas, particularly if a slowdown in US growth continues.

Article continues after advert

Newton fixed income portfolio manager Parmeshwar Chadha said the US credit market was on a “precarious footing” and expects global speculative grade default rates to move above 5 per cent by the end of 2016.

“So far, most of the defaults in the US have been in the commodity sectors, though as the US economy slows in the second half of the year, we expect a pick-up in defaults in the non-commodity sectors such as retail,” he said.

Mr Chadha explained the combination of an economic slowdown and an already struggling high-yield market would cause the spillover.

“Our expectation of a slowdown in the US economy in the second half of the year will put further pressure on top-line revenue growth rates for retailers, making it even harder for them to service their large debt obligations,” he said.

Global high-yield trailing 12-month default rates stood at 3.1 per cent as of March 31, according to Standard and Poor’s (S&P) Global Ratings, with the US figure at 3.9 per cent. The firm similarly warned of a “spillover” into other non-industrial sectors.

There have been 72 defaults so far this year compared with 39 in the same period in 2015, the ratings agency said. Of these, 29 had come from the oil and gas sector and 12 from mining and metals. There were 53 defaults in the US.

S&P said it expected the US default rate to hit 5.3 per cent by March 2017, a rise of 3.5 percentage points in two years.

It cautioned: “So far, there has been little spillover effect into other sectors, but we are not ruling this out in the coming quarters.”

However, JPMorgan Asset Management global market strategist Vincent Juvyns said he was not convinced about the risk of contagion, given the recent spike in the oil price.

He said many of the defaults were due to market volatility seen at the start of the year, which he did not foresee reoccurring to the same intensity later in 2016.

The strategist added US oil and gas defaults would be around 11 per cent at the current oil price level of around $50 per barrel. Mr Juvyns said he was not bearish on other sectors, but did acknowledge rising leverage rates. “The rising leverage level in the US is worrying. But at this point in the cycle and level of interest rate it is not surprising, and could be classed as good management,” he added.