US corporate debt
In 2019, around 50% are. 33 If these bonds were to be downgraded to a junk bond, many private sector corporates would be required by their mandates to dump them. This leads to decline in investment, economic growth and job creation, making the financial system constrained and lacklustre. 34 The system would only be tested if it began to look as if ‘more corporate debt was likely to turn sour’. 35 There are two obvious threats which might bring that about: falling profit margins and rising interest rates. Recently, interest rates looked like the bigger worry. Interest rates prima rily influence a corporation’s capital structure by affecting the cost of debt capital. With central banks beginning to raise interest rates, the risk that some companies could run into difficulty keeping up with repayments will be heightened. This will cause increased leverage-loan and CLO defaults, and in the case of an economic downturn, these defaults could amplify the effects of a downturn due to lower investment and higher default rates. The Economist Intelligence Unit said that ‘in this scenario, a US recession would exacerbate a global slowdown, with countries affected by declining US demand for goods and investment’ . 36 Nevertheless, falling profit margins are also of concern. The S&P 500 finished the initial six months of 2022 with a loss of 20.6%, shedding some $8.5 trillion in market value as the index logged its steepest fall since 1970. 37 With the combination of higher supply costs, skyrocketing inflation and recession looming, profit margins are certain to fall. Should the world economy continue to deteriorate, the most indebted businesses will begin to run into trouble. In the corporate world, debt is the norm. It is crucial for raising finance to support company operations or potential expansions of business activity. Considering the US is the world’s leading economy, it is no surprise that the country is also very much at the front of this debt-driven economic world. But with the cost of servicing debt rising and the market falling, a wave of downgrades to junk status would spark a corporate-bond sell-off and corporate debt would run into danger. Retail investors would withdraw their money from funds exposed to leveraged loans and corporate bonds causing bankruptcies to rise and investment to drop. The worst-case scenario remains on the same wavelength as the havoc wrought by CDOs a little over a decade ago, illustrating the fragilities that have been created by the credit boom, and that America could once again face a debt-driven turn in the economic cycle.
Bibliography
Abedian, Iraj. 2016. ‘The how, why and what of a downgrade to junk status.’ politicsweb , 13 May. Ahmed, Saqib Iqbal. 2022. S&P 500 ends brutal first half '22 with largest percentage loss since 1970. 30 June. Accessed August 24, 2022. https://www.reuters.com/markets/europe/brutal-first-half-22-track-shave-8-trillion-off-sp-500- 2022-06- 30/#:~:text=The%20S%26P%20500%20%28.SPX%29%20finished%20the%20initial%20six,20%25%20from%2 0its%20January%20record%20peak.%20read%20more Atesa gaoglu, Orhan Erem . 2012. ‘TAXES, REGULATIONS AND THE CORPORATE DEBT MARKET.’ International Economic Review (Wiley) 53 (3): 979-1004. Accessed August 19, 2022. https://www.jstor.org/stable/23251504 Bruno, Alessandro. 2017. ‘The 2008 Financial Crisis Explained.’ Edited by Alessandro Bruno. Lombardi Letter. Accessed August 22, 2022. https://www.lombardiletter.com/the-2008-financial-crisis-
33 Ibid. 34 Abedian, ‘ Downgrade to junk status ’. 35 The Economist , ‘America’s corporate debt mountain’. 36 Ibid. 37 Ahmed, ‘S&P 500 ends brutal first half ’22’.
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