Bonds, default rates go up

The central banks' monetary tightening, considered necessary to fight inflation, also brings with it some inherent albeit unintended consequences. One of these is the number of corporate defaults, which globally rose to 107 as of Aug. 31, 2023, with 16 defaults in August, the highest monthly figure since 2009.

This was revealed in a report by S&P, which found that defaults in the media and entertainment sector since the beginning of 2023 are six times higher than those recorded in 2022. The main pressure point within emerging markets is Latin America with 13 of the 14 defaults recorded since the beginning of the year.

The agency then predicts that 12-month speculative grade default rates in the United States and Europe will continue to rise from current levels of 4.5 percent and 3.75 percent, respectively, by June 2024.

"The increase in default rates globally can be attributed to the aggressive monetary tightening implemented by the major central banks over the past year and a half," confirms Paolo Baldessari, Asset Management Area at Banca Generali where he is Head of Fixed Income & Alternatives. "The increase in insolvencies has been particularly pronounced in the U.S. where, alongside the Fed's restrictive monetary policy, companies have also had to deal with conditions of access to credit that have become much more restrictive after the failure of Svb and some regional banks," adds the expert.

According to Baldessari, it is easy to foresee that the number of bankruptcies in the U.S. are likely to increase, given the tight maturities of debt: one-third of U.S. 'High Yield' bonds are in fact due for refinancing in the next two years. "We are facing complex market conditions where it is important to approach with proper prudence and the guidance of experienced professionals who can recognize the risks that inevitably lurk even in assets under administration." Yes, because the coupon appeal that savers have been yearning for for too many years also presents another side of the coin, namely the critical issues for companies from a cost of debt that has risen exponentially in the space of two years.

"Bonds are in this 2023 the focus of investor interest, but you need to know how to assess the issuer's fundamentals and build appropriate diversification as you typically do with active management, in specialized funds or in bespoke asset management," explains Baldessari, who then reassures on the different approach in Europe compared to America. "The European credit market enjoys a different robustness; here the default rate has only gone from 0.4 percent at the end of 2022 to 2 percent at the end of August," he warns. "According to the majority of analysts, the rate is set to rise to stabilize between 3 and 4 percent, which is far less worrisome than it was during the European sovereign debt crisis or, more recently, during the period of the Covid-19 pandemic. European debt maturities are also less challenging than those in the US. Much of the closer maturities have already been repaid or refinanced. As for debt maturing in 2025, 14 percent has already been refinanced well in advance and, in only 1 percent of the cases, involved a 'distressed exchange,' that is, a high-loss exchange for bondholders," Baldessari concludes.