Moody’s data for October shows that default rates continue to increase, see the first chart below.
This is not surprising. Default rates will continue to trend higher. Why? Because the rise in default rates is engineered by the Fed. The Fed is in the process of slowing down the economy with the goal of getting inflation back to the FOMC’s 2% target.
In other words, the ongoing rise in default rates is not just a “normalization.” It is the direct consequence of Fed hikes. The Fed is trying to slow the economy down.
Total employment of companies in the high yield index is 11 million, and total employment of companies in the leveraged loans index is 8 million, see the second chart below.
With interest rates staying high at least until mid-2024, the downside risks to employment continue to be meaningful because the goal of the Fed is to soften the labor market and lower inflation. And the only tool they have is to keep interest rates high until they get what they want, namely inflation back at 2%.
Our latest credit market outlook is available here. Investors should be up in quality and stay away from small-cap highly leveraged companies with low coverage ratios and weak cash flows because those companies will be particularly vulnerable to high costs of capital and slowing earnings growth.
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