Corporate defaults could be about to rise, according to two leading financial institutions, Deutsche Bank (DB), and ratings agency Moody's, who have both warned this morning that the business cycle could be about to take a turn for the worse.
Analysts from Europe and the United States at the DB today launched their closely-watched annual default study, and say they expect the number of companies unable to pay their debts will tick up over the next few years, while Moody's said that the default rate on higher-risk "speculative" debt is going to increase in the next 12 months.
“In spite of all the challenges we face, this era has been characterised by astonishingly low default rates,” DB said. “There are clear signs the cycle is turning though, especially in the US.”
"The corporate default cycle has turned and is on the rise," Moody's said.
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Three key indicators which have historically predicted a rise in the number of defaults – debt levels, tightening monetary policy combined with flatter yield curves, and the possibility of an external shock – are all flashing red, according to DB.
“The pieces of the jigsaw are building. US corporate debt accumulation now compares with that seen prior to previous default cycles. Equity volatility has seen two spikes in the last year, bank equity is falling, and global yield curves continue to flatten.”
The warning, while tempered by the fact that DB believes that “the next default cycle could still be contained,” comes off the back of Societe Generale analyst, Albert Edwards, warning that the US economy was about to be “swept away by a tidal wave of corporate default”.
The unprecedented era of monetary policy in Europe, where the European Central Bank (ECB) is currently buying not only government debt but also corporate bonds through its €80bn (£64bn) a month quantitative easing programme, will limit the rate of default to somewhere between five and seven per cent, DB reckons.
Globally, the default level increased from 0.9 per cent to 2.7 per cent in 2015 – though this was “still lower than all of the first two decades of the modern era of leveraged finance up to 2003”.
Moody's said that it expected defaults in the energy sector, under particular stress due to the weak oil prices, to remain around 10 per cent for the foreseeable future
If the default rate in the US increases and this spills over into an American, or even a global recession, however, DB said that their outlook would change, warning that “the era of heavy financial repression and very active central banks” means that predicting how severe the looming default cycle will be is a tricky business.