After the binge, the hangover. The huge rise in corporate leverage combined with an
uncertain economic outlook increases the chances that debts will not be repaid in full or
on time. Bond defaults have already picked up sharply. By early October the 12-month
trailing rate of default on junk bonds had risen to 6.3% in America and 4.3% in Europe,
according to s&p, a rating agency. More defaults will follow in 2021.
How bad things get depends on a tussle of opposing forces. One is the virus and its
lingering effects. Almost no one expects the economy to have fully recovered by the end
of 2021. In October, in its twice-yearly World Economic Outlook, the IMF forecast that
America’s GDP will return to its 2019 level only in 2022. Already it is clear in Europe
that the rebound in activity from the trough of recession in March and April is losing
momentum, because of a resurgence of infections. A faltering recovery puts more
corporate-bond issuers at risk of default.
Yet there are powerful influences working in the other direction. One is fiscal policy.
The various government-led short-time working schemes, furloughs and support
programmes have helped keep a lot of financially stressed companies alive. A big
concern is that fiscal stimulus will be withdrawn too abruptly, as it was in Europe after
the global financial crisis of 2007-09. But lessons have been learned. The establishment
of a euro-area Recovery Fund is one encouraging sign. Early indications from France,
Germany and Italy suggest that fiscal policy will remain broadly supportive in 2021.
And further stimulus is on the way in America, one way or another.
A second factor is bond-market liquidity. The burst of issuance during 2020 owed a lot
to America’s Federal Reserve, which said in March that it stood ready to buy corporate
bonds, prompting investors to start buying bonds in anticipation. The markets unfroze.
Big firms could raise plenty of cash to tide them over. Rich-world central banks,
including the Fed, are committed to keeping monetary policy extremely loose. And
investors will buy new corporate-bond issues, and roll over old ones, if only for the lack
of good alternatives. Yields on government bonds are vanishingly small in America. In
Europe the safest bonds have negative yields. Corporate bonds are riskier, but have
higher yields to compensate.
Credit is the lifeblood of the economy. As long as firms can borrow, they can survive.
That is why the corporate-bond market sets the tone for riskier assets, such as shares.
There will be more corporate defaults, thanks to a weak recovery and high debt. But
cheap money and fiscal support will keep a lot of big firms alive that would otherwise go
to the wall. Defaults will peak at lower levels than seemed possible in the spring of 2020.
The angels that have already fallen will not be further disgraced. A few may even find
redemption in 2021.
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