Key Takeaways
- Following recent positive revisions to our U.S. economic projections and a continued decline in speculative-grade negative bias (the proportion of ratings with negative outlooks or on CreditWatch negative), we are lowering our estimate for the 2021 U.S. default rate to 5.5%, from our 7% projection in February.
- The passage of the $1.9 trillion fiscal stimulus package, alongside the continued rollout of COVID-19 vaccinations, is benefiting the economy and could lead to a stronger and earlier economic rebound than we previously anticipated.
- Nonetheless, the credit impact of the pandemic will linger for certain sectors, and we could see a protracted period of historically elevated default activity.
- We think concerns about inflation may be overblown and that orderly reflation--consistent with solid economic growth--would be a healthy development. Speculative-grade yields remain low, having risen only slightly from all-time lows in late 2020.
Chart 1
S&P Global Ratings Research expects the U.S. trailing-12-month speculative-grade corporate default rate to fall to 5.5% by December 2021, from our prior estimate of 7% (see chart 1). This follows strong economic data and our economists' upward revision to their growth forecast for 2021, as well as a decline in downgrade potential for our speculative-grade population in the U.S. Concerns over inflation have grown in recent months, though we do not expect a period of high or sustained inflation (see "Orderly Global Reflation Will Support The Recovery From COVID-19," March 22, 2021).
Given the large numbers of defaults in April to July 2020 that will shortly fall out of the trailing-12-month default rate calculation, we expect that the default rate has most likely hit its peak, or will through the end of March.
Credit Quality Improves Ahead Of Strong Economic Recovery
We now expect economic growth in the U.S. to reach 6.5% in 2021, from 4.2% in our December forecast (see chart 2). This has lowered our economists' recession risk assessment to 10%-15%, from 20%-25% previously. An improving vaccination outlook, faster reopening schedule, and the $1.9 trillion stimulus, along with a $900 billion package approved in December, all point to a significant shift in the U.S. economic outlook relative to December 2020. Business and consumer confidence are both reflecting a healthy economic expansion as well.
Chart 2
One area where we may see a longer path to recovery (than overall GDP) is unemployment. The unemployment rate has historically been a key indicator for corporate defaults and is experiencing a slower return to its pre-COVID-19 norm. That said, our economists have positively revised their expectations for unemployment (see chart 3). They see the unemployment rate falling to 5.1% by fourth-quarter 2021, one percentage point lower than without the American Rescue Plan, and hitting precrisis levels by mid-2023 (adjusted for labor composition), three quarters sooner than otherwise.
Chart 3
Alongside an improving economy, negative bias is signaling improved credit quality in the near term. Since its peak of 52.5% in May 2020, negative bias (the proportion of ratings with negative outlooks or on CreditWatch negative) fell to 31.1% as of March 23 (see chart 4). And only a small portion of our negative bias is CreditWatch negative placements--which carry a shorter time frame and higher likelihood for potential downgrades (of 90 days and at least a 50% chance of downgrade).
Chart 4
In addition to an improved outlook for credit quality relative to mid-2020, the pace of speculative-grade downgrades has slowed considerably, and upgrades have picked up in recent months. At the lower end of the speculative-grade spectrum, the monthly pace of downgrades for 'B-' (to the 'CCC'/'C' category) slowed in the second half of 2020, and upgrades have outpaced downgrades more recently (see chart 5). Net rating actions for the U.S. 'B-' population totaled 135 downgrades between January and July 2020, but have moved to a net 10 upgrades since August 2020.
Chart 5
There have been concerns raised recently over the possibility of a bout of inflation in the U.S. this year, and Treasury yields have started to climb at a historically fast pace. That said, while corporate yields have also risen, they have not done so at the same pace--particularly for speculative-grade issuers (see chart 6). In fact, corporate yields are merely coming off of their all-time lows experienced in the latter half of 2020, and they have some room to go before reaching their 2011-2019 ranges.
Chart 6
Historically high market appetite for speculative-grade debt in 2020 helped push borrowing costs on bonds to these new lows. This was not necessarily reflected in the speculative-grade spread, but that was largely due to Treasury yields also reaching new lows last summer. Arguably, this unusual environment was supported by the Federal Reserve's previously unused policy tool of directly buying new and existing investment-grade corporate bonds, which was extended last April to include bonds of recent fallen angels.
In our view, an orderly reflation will support the economic and credit recovery after COVID-19. In fact, some amount of reflation would indicate greater confidence for a sustained recovery in the U.S.
But The Recovery Will Have Lingering And Uneven Risks
A strong economic recovery is now our base-case assumption for the U.S. in 2021. And while this should result in renewed revenue for many sectors that struggled through 2020's lockdowns and suppressed activity, the impact on creditworthiness has been noticeable, and will remain. Our current rating mix among U.S. speculative-grade entities remains particularly weak--the proportions of both 'B-' and lower ratings, and 'CCC'/'C' ratings are still near their all-time highs reached in 2020 (see chart 7). Default rates for these ratings have been high historically, leaving the potential for increased defaults once the economic recovery's pace slows toward the longer-term rate.
Chart 7
While the overall speculative-grade population in the U.S. has a noticeably weaker rating distribution as a result of downgrades in 2020, the underlying credit stress has not been evenly felt across sectors (see chart 8). The sectors most affected by the pandemic have particularly weak distributions, such as retail/restaurants, consumer products, and media and entertainment. Together, these sectors account for roughly one-third of all speculative-grade issuers in the U.S., and they have higher proportions of ratings in the 'CCC'/'C' category than speculative grade overall. In fact, these three sectors account for 45% of all 'CCC'/'C' ratings in the U.S.
Chart 8
Looking ahead, we don't expect the recovery in credit metrics to be uniform across sectors. Many subsectors are likely to see their credit metrics return to 2019 levels by 2022 or 2023 (see "COVID-19 Heat Map: Some Bright Spots In Recovery Amid Signs Of Stability," Feb. 17, 2021). While we are revising down our default projections for 2021, credit stress remains high and could result in a historically elevated default rate as the economic recovery slows to a more normal rate. In particular, we could see the speculative-grade default rate remain in excess of--potentially for a protracted period--the long-term average, which is currently 4.2%.
S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Related Research
- Economic Outlook U.S. Q2 2021: Let The Good Times Roll, March 24, 2021
- Orderly Global Reflation Will Support The Recovery From COVID-19, March 22, 2021
- COVID-19 Heat Map: Some Bright Spots In Recovery Amid Signs Of Stability, Feb. 17, 2021
This report does not constitute a rating action.
| Ratings Performance Analytics: | Nick W Kraemer, FRM, New York + 1 (212) 438 1698; nick.kraemer@spglobal.com |
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