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The Outlook for the Corporate Credit Default Cycle
- Rising financial distress, defaults, and downgrades are anticipated to persist for the foreseeable future, driven by recession depth and cyclical challenges, particularly for lower-rated investment grade and high yield firms.
- Risks related to abrupt credit availability contraction and secondary market liquidity impairment are expected to have materially abated since the Federal Reserve's corporate credit facility launch in March, with liquidity measures normalizing over the past three to four weeks after reaching levels exceeding those of the global financial crisis.
- The Federal Reserve's March 23rd announcement is projected to be viewed as a key inflection point for credit markets, coinciding with a surge in dollar new issue volumes where investment grade year-to-date volume already rose over 85% compared to 2019.
- While an unprecedented spike in high yield defaults is expected to be avoided, high yield defaults are forecasted to gradually increase over the remainder of the year, with a specific annual default rate of 13% cited as a forecast by 2030.
- The severity of the economic shock is expected to continue eroding earnings and balance sheet quality, incentivizing defaults; however, corporate liquidations remain expected to be rare, with the vast majority of distressed companies undergoing Chapter 11 in-court or out-of-court restructurings.
- Companies emerging from restructuring are typically expected to do so within 12 months or two years and emerge stronger, though an unusual increase in Chapter 7 liquidations will be closely monitored as an indicator of permanent economic damage.
- Sector performance expectations anticipate those unaffected by sudden economic stops will continue outperforming, while social distancing-impacted sectors will gradually recover as the economy reopens, with the energy sector expected to see a recovery in the next couple of months for high-quality credits with solid balance sheets.
- A rotation from defensive to cyclical sectors in the credit complex is expected upon successful economic reopening, underpinning broader risk asset recovery.