Fading optimism on US rates signals trouble ahead for $580.3 billion debt wall

Friday’s sizzling jobs report is bolstering the probability of another Federal Reserve rate increase in 2023, adding to pain in credit markets that are already hurting from a year-long jump in yields. 

According to the United States Department of Labour, the country generated 336,000 jobs in September, following an upwardly revised gain of 227,000 payrolls in August.

The strength of the US labour market increases the likelihood that the central bank will not pivot to cutting rates in 2024. That is a big negative for corporate America, which has continued boosting its debt levels even as yields have surged over the last year. 

Two data points that highlight the extent of corporate trouble: companies have about US$425 billion (S$580.3 billion) of dollar-denominated junk debt due to mature before the end of 2025, and market yields for speculative-grade bonds are now at least 3 percentage points higher than the average coupon the borrowers are paying on their existing debt. 

The higher borrowing costs that many companies face could cut into profits and increase default risk. Rates staying higher for longer will likely have some kind of unexpected impact on the economy, Mr Mohamed El-Erian, chief economic adviser at Allianz, said in an interview with Bloomberg TV. 

“This is likely to be bad news for markets and for the Fed,” Mr El-Erian said after the US jobs data was published on Friday. “Something is likely to break, probably in the financial markets, but that will spill back into the economy.” 

Even before the jobs report, worries about rising yields had shut down new junk bond sales in the US, bringing the first “zero” week since the week ended Aug 18, according to data compiled by Bloomberg News.

That came as the 30-year US Treasury bond last week breached 5 per cent for the first time since 2007, crystallising just how challenging and expensive it is going to be for some issuers to deal with their debt.  

“The junk bond market needs to massively reprice to account for refinancing risk with benchmark borrowing rates so high,” said Ms Althea Spinozzi, a strategist at Danish lender Saxo Bank. “I can’t see how the default rate doesn’t rise sharply and there will be stretched balance sheets everywhere.” 

That kind of thinking helped lift the average yield on the Bloomberg Global High Yield index to 9.26 per cent last week, the highest since November 2022 and nearly double what it was at the start of 2022. The drought in new sales followed more than US$23 billion in issuance in September, the busiest month since January 2022.

Economic uncertainty and higher yields make it harder to sell debt.

Barclays held preliminary discussions with investors about refinancing a private loan for Hibu, the former Yellow Pages publisher, but found tepid interest from loan buyers and the deal was scrapped.

Separately, a planned sale of a portfolio of European leveraged loans worth €290 million (S$419 million) was shelved. 

Refinancing at higher yields is painful, and many loan borrowers are already feeling the heat: benchmarks for the floating-rate debt have been consistently adjusting higher since 2022.

If rates are higher for longer, then junk bond borrowers face greater risk of having to adjust their coupons materially higher too, said Mr Sinjin Bowron, portfolio manager at Beach Point Capital.

The rapidly growing corporate private credit market will probably also see more defaults, with Bank of America strategists estimating it could reach 5 per cent in 2024, exceeding those in the syndicated loan market.

For at least the near term, companies that had planned to come to the market offering risky bonds and loans will probably think again.

“Credit markets are likely to remain under some modest pressure through early November and a combination of earnings blackouts and materially higher borrowing costs should keep issuance fairly limited through October,” said Ms Winnie Cisar, global head of strategy at CreditSights. BLOOMBERG