Corporate debt is booming but the global economy might not be in part due to coronavirus.
The more than $13 trillion in debt that global corporations have amassed since the 2008 financial crisis has yet to worry investors, but that may change soon.
Into an increasingly negative economic picture comes a wild card, the global spread of coronavirus. The disease’s spread outside China’s borders continues unabated, disrupting global supply chains for tech companies like Apple as well as Indian and American drug companies that may soon have to cope with shortages because of their reliance China, the world’s second largest economy.
“When [corporate debt] markets are as robust as they have been, this kind of thing could shake investor confidence and impair liquidity in the market,” said Moody’s senior credit officer Ed DeForest. “One of the quickest things to turn could be liquidity. If institutions and retail investors turn on the asset class, it will precipitate other problems.”
For now, the debt is cheap. With central banks around the world suppressing interest rates, corporations—particularly low-rated issuers—have loaded up on debt. They can cover the interest costs more easily and can regularly refinance as rates have continued to trend downwards.
However, the easy money may soon dry up as signs of a slowdown in global economic growth accumulate. The latest report on 53 industry sector outlooks by credit rating agency Moody’s suggests that a day of reckoning may be approaching. The bulk of those sectors, which don’t include service industries, still have stable outlooks, but the number that now have negative outlooks has risen to 15—the highest number since the oil and gas recession in 2015-2016. They include the global automotive industry, steel production, European retail and global manufacturing. Only four sectors—global beverages, U.S. medical products and devices, global midstream and refining and marketing—have positive outlooks. That is the lowest number of positive sector outlooks since the 2008 financial crisis.
“While the core of outlooks remains stable, the reversal from 2018 is a pretty quick move,” noted DeForest. “It flashes a warning of weak underlying business conditions.”
The biggest cause of that weakness in 2019 was the global trade picture, as the U.S. and China slapped tariffs on each other. The “Phase 1” deal signed between the two countries earlier this year has reduced uncertainty to some degree, but trade wars could continue to damage economic growth.
To date, credit rating downgrades and defaults on corporate debt have remained extremely low in large part because money remains cheap and plentiful. The spreads on the lowest rated debt in the U.S. trended up slightly last year, but overall liquidity is still extremely favorable for corporate borrowers.
The good news is that companies have been able to extend the maturities of their low-yielding bonds and loans, giving them time to fix problems and/or improve their business outlook. The bad news is that with so much of the $13.5 trillion in debt concentrated in speculative-grade issuers and in the lower end of the investment grade spectrum, these problems may not be fixable. A turn in this twelve-year economic cycle could make the eventual day of reckoning a lot more painful.