A surge in US corporate defaults looks unlikely

Hello and welcome. My name is Adam Slater, Lead Economist at Oxford Economics. This week we’ve been looking at the corporate defaults cycle in the United States and where default rates might go from here. So far, despite a big rate hike cycle, the US speculative grade default rate has only risen modestly to about 4%, which is a lot lower than the peak 10 to 12% levels seen in some previous default cycles.

Now, some observers have been suggesting there could be a big rise in corporate defaults ahead, but we’ve done some modeling that suggests that is unlikely unless the macroeconomic picture deteriorates dramatically. Our model predicts the US speculative default rate using industrial production growth, unemployment, interest rates and a proxy for the health of corporate balance sheets. And using our baseline forecast for the US economy our model suggests there’ll be only a modest further rise in the speculative default rate to about 4.9%.

A mild recession scenario could push the default rate to 5.8%, but even a hard landing featuring a peak 5% year on year drop in industrial output would only push up the default rate to around 7%, according to our modeling. So on this basis, the probability of the default rate reaching 10% again, as in some previous cycles, looks low.

We think our relatively benign outlook for default rates will allow US high yield spreads to trade below 400 basis points throughout this year. And this suggests that high yield credit could well outperform US duration and equities this year.