By Anna Chong, Deputy Head of Corporate Credit Research, Federated Hermes Limited
The new year promises to be a challenging one for highly levered corporates with looming maturities. Who will be hardest hit?
When considering our outlook for the coming year, it’s fair to say that not all the signals are flashing green.
For one thing, the macroeconomic backdrop remains lacklustre. Rates may no longer be rising but the effects of the recent hiking cycle continue to filter through to the real economy. Key macro data underline this: Eurozone manufacturing PMIs came in at 43.8 for November, indicating still-tough conditions for Q4 reporting for European industrials. Likewise, the big Chinese post-pandemic reopening was one of 2023’s bigger disappointments. As things stand, we don’t expect material change in the coming 12 months.
Looking into 2024, markets have shown optimism over October and November, but even the so-called ‘goldilocks’ scenario of a soft landing implies it will be slow growth rather than anything more benign that will be the limiting factor on inflation. The ‘best-case’ scenario, then, is essentially the economy slowing just enough to temper inflation without falling into recession.
In short, we’re faced with an unstable equilibrium. If the economy stays too strong then inflation likely remains too high and central banks will likely disappoint on cuts in 2024. If the cooling is too strong then the economy risks a more damaging recession scenario.
Also read: Local Markets Price Less Aggressive Path For RBA
What does this mean for fundamentals?
Last year we saw a hit to earnings. This is due to a mixture of destocking effects from the post-Covid bullwhip, which dampened volumes, coupled with cost inflation that is still hurting margins. Companies are now in a battle to cut costs against a persistent backdrop of destocking and weak industrial demand.
Though the Federal Reserve may start lowering rates later this year, we’re still a long way from the ‘cushy’ low rate environment of the past decade, and this is putting the squeeze on both consumers and corporates – and impacting the cost of funding.
Even though corporates in the high yield market have, by definition, a fixed rate on their debt, this only lasts as long as their maturities. Currently, 28% of CCC bonds are due by 2026. So when it comes to refinancing, we can begin to expect some sticker shock on new coupons as they come through.
