Global credit risks are on the rise amid hikes in interest rates, the European energy crisis, and China’s beleaguered property market, among other threats, Fitch Ratings observes in its latest Risk Headquarters report. 

While Fitch’s base-case forecasts were revised in September to include recessions in the US and Europe in 2023, the broad-based risk environment remains to the downside, the credit rating agency noted.

Factors intensifying credit risks

“Core risks that would materially heighten credit risks include the failure of the European gas market to balance, sustained high inflation in the US and Europe through 2023, the Chinese property market and the extent to which a lack of recovery may spread risks to other sectors, the progression of the Russia-Ukraine war, the pace of housing market corrections in developed markets, and policy missteps as authorities react to economic and social pressures”, Fitch said.

The US Federal Reserve (Fed) and other central banks around the world continue to raise interest rates to combat inflation. Amid tightening economic and financial conditions, corporations worldwide, including those in the US, are feeling the pinch of higher borrowing costs that have made them rethink new acquisitions, expansion plans and other big investments. Rising interest rates are likely to intensify credit risk concerns.

In addition, the list of key global credit risks has also been updated by Fitch to reflect the evolving environment. These risks include ‘stagflation’, ‘debt overhang and financial instability’, ‘China macro and financial risks’, ‘governance and policy risks’, and ‘climate transition’, Fitch added.

‘Governance and policy risks’ was added to highlight the growing potential for economic policy missteps amid high inflation and a recessionary outlook, Fitch pointed out. Furthermore, heightened geopolitical risk and shifting long-term policy agendas are leading to greater policy uncertainty, the Risk Headquarters report stated.

US high-yield bond default rate to rise

As the economic outlook dims, Fitch projects that the US high-yield bond default rate will rise. Fitch forecasts a default rate of 2.5-3.5% at the end of 2023, still below the 3.8%, 21-year historic average, while rival credit rating agency Moody’s forecasts a slightly higher default rate of 4.3%.

Fitch anticipates 2023 will produce approximately 30 defaults, up from 13 so far this year and 11 in 2021. “The 2023 anticipated default rate equates to roughly US$40 billion of volume, in line with the amount tallied in 2019, but less than the 2016 and 2020 figures and well below 2009’s $113 billion”, said Fitch in a release last month.

Fitch believes that the defaults in 2023 will be concentrated in retail, telecommunications and broadcasting/media sectors. These sectors may reach double-digit rates and are expected to comprise roughly half of 2023’s default volumes.

US housing market under tremendous pressure

Besides higher borrowing rates that are weakening business spending, high and persistent inflation that is depressing economic activity, looming recession in the UK and Europe, China’s economic slowdown, and roiling financial markets that are threatening to erode the revenue and profits of American corporations, there is the domestic housing market that is being hammered by rising mortgage costs.

The US housing market, particularly vulnerable to higher inflation and interest rates, is beginning to choke, and given that housing is considered as a bellwether for the rest of the US economy, any cooling or contractions will inevitably threaten spillover effects in other major industries, such as home builders, realtor businesses, home-improvement retailers, appliance makers, in-home entertainment companies and consumer electronics companies, as well as weighing on broader corporate growth and leading to tougher credit consequences.

In conclusion, as US corporate credit risk is rising on the prospect of higher corporate funding costs, geopolitical and global economic uncertainty, rising inflation, the energy crisis, the UK’s and Europe’s looming recessions, and a domestic housing market slowdown, finance chiefs and corporate treasurers will need to step up oversight and risk management tools at their disposal to measure and mitigate credit risks, keeping default rates low and reducing the severity of losses.