S&P Global Ratings Credit Research & Insights expects the U.S. trailing-12-month speculative-grade corporate default rate to fall slightly to 3.25% by September 2025 from 4.4% in September 2024 (see chart 1).   The default rate has been falling since April as inflation has declined, economic growth remained strong, and the Fed cut rates. Issuance year to date has also been strong, up over 60% relative to last year. The vast majority has been used to refinance upcoming maturities, helping to ease near-term liquidity. We expect growth to slow but remain strong enough to sustain a soft-landing, with more rate cuts ahead. Market rates have been falling, albeit more slowly than they rose, but spreads remain close to their all-time lows of earlier this year. We feel this backdrop implies the default rate will continue to decline.

Chart 1

In our optimistic scenario, we forecast the default rate could fall to 2.25%.   In this scenario, interest rates would fall faster than anticipated if a similar descent in inflation leads the way--but this has proven elusive thus far. This would need to offset the slowdown in growth largely expected in the coming quarters, which could surprise to the upside as it has in the last year. Even in this scenario, we'd expect the default rate to fall less quickly than it rose (since 2023), albeit only moderately so.

In our pessimistic scenario, we forecast the default rate could rise to 5.25%.   Although our economists don't expect a recession, if one were to occur, the default rate could rise quickly. However, with the results of the recent general election, we feel there's an increased likelihood of more tariffs and potential for subsequent inflation, possibly resulting in a slower pace of rate cuts. Tariffs take time to formalize and implement, and most of the weaker issuers are from service sectors, helping to limit--but not completely remove--their impact. Service sectors could be affected through changes in immigration policies if they have subsequent effects on labor markets, but much is still unknown. Any changes are more likely to affect defaults beyond this forecast horizon, although some initiatives could be enacted more quickly with the potential to affect defaults later in 2025.

Uncertainties don't automatically result in increased defaults, but there is arguably a higher vulnerability with the current population given its still weak rating distribution since 2020 (see chart 2). Although we are calling for a falling default rate in our base case, we maintain the 5.25% downside possibility in light of these sensitivities.

Chart 2

Near-Term Relief, But At A Cost

This year has been marked by a strong rebound in issuance and a historic tightening in spreads. Firms took advantage of this to reduce near-term refinancing needs, pushing upcoming totals down through at least 2028 (see chart 3). After two years of lackluster issuance, the over 60% increase in 2024 so far has been a welcome reprieve for many issuers who were able to address near-term liquidity needs. However, this relief valve may have come at a cost.

Chart 3

After the financial crisis and up to the Fed's recent rate-tightening cycle that began in 2022, most issuers enjoyed a prolonged period where coupon rates on new bonds were reliably lower than those on maturing bonds (see chart 4). As an example, on average, new bonds rated 'B' carried coupons roughly 190 basis points (bps) lower every quarter from mid-2014 through the first-quarter of 2022. Since then, coupons on new bonds have averaged 150 bps higher. We expect rates to decline more in 2025, but the full extent of declines may prove more modest than expected as recently as two months ago.

Chart 4

If renewed concerns over a rebound in inflation as a result of potential changes to trade, immigration, and the pace of the government's deficit growth are going to keep the pace of interest rate declines ahead on a slow decent, this could keep the expected decline in defaults on a slower path as well.

Bond Spreads Have Been A Good Indicator Of Future Stress…

Bond spreads widened quickly in the week through Aug. 5, but they have tightened since. Bond spreads have spent the better part of 2024 setting new lows, supporting a wave of general optimism.

The U.S. speculative-grade corporate spread indicates future defaults based on a roughly one-year lead (see chart 5). At 271 bps in September, the average speculative-grade bond spread implied a much lower default rate by September 2025. Even loan spreads--which ended September at 453 bps--remain relatively favorable given the large percentage of leveraged loans in the U.S. rated 'B' and 'B-'.

Chart 5

That said, the corporate distress ratio is a more targeted indicator of future defaults across credit and economic cycles, especially during periods of less stress. The distress ratio indicates future defaults with a roughly nine-month lead. The 4.8% distress ratio in September would approximately correspond to a 2.4% default rate for June 2025 (see chart 6).

Chart 6

…But May Still Be Too Optimistic

Using the CBOE Volatility Index (VIX), the Institute for Supply Management Purchasing Managers' Index, and components of the money supply, we estimate that in September, the average speculative-grade bond spread in the U.S. was about 218 bps below the implied level (see chart 7).

For an extended time, our estimated spread has been elevated relative to the actual bond spread. Recent market volatility, which included rapid spread widening, support this.

Chart 7

Primary Markets Remain Receptive In 2024

Optimistic spreads often signal opportune times for companies to come to the market, and spreads this year have certainly reflected that. A total of $795.1 billion in high-yield bonds and leveraged loans was issued between January and October--second only to the record $1.0 trillion issued during the same period in 2021 and nearly twice the amount issued during the same period last year (see chart 8).

Chart 8

Moderate Overall Improvement In Credit Indicators Continues

Market signals had been bullish, but many other credit and economic indicators remain more challenging (see table 2). Bank lending conditions continue to tighten, the yield curve remains inverted after nearly two years, and the number of weakest links is still elevated. (Weakest links are issuers rated 'B-' or lower by S&P Global Ratings with negative outlooks or ratings on CreditWatch with negative implications.) Credit conditions appear to be stabilizing recently, but defaults remain slightly above the long-term average.

Table 1

Positive Rating Momentum Continues

Upgrades have outweighed downgrades over the past 12 months, and we expect the number of negative rating actions to moderate since the negative bias for issuers rated 'B-' or below has fallen (see chart 9). In light of this modestly positive rating momentum, a major spike in defaults appears to be unlikely in the near term.

Chart 9

In the third quarter, just four of the 13 sectors had a positive net bias, and seven had negative net rating actions (see chart 11). (We define net bias as the share of issuers with ratings that have positive bias--meaning ratings with positive outlooks or ratings that are on CreditWatch with positive implications--minus the share of ratings that have negative bias.)

Chart 10

Consumer-reliant sectors accounted for 51% of U.S. defaults in 2023, and the state of the consumer has deteriorated in the three quarters ended Sept. 30. The consumer products sector has the second highest number of defaults in the U.S. through the third quarter (16), only slightly behind media and entertainment (17). The consumer products sector also had the highest number of weakest links at the end of September, with 31, though this has moderated since the beginning of the year. High interest rates and persistent inflation have depleted consumer savings and lowered discretionary income, particularly for lower-income borrowers.

The health care sector had the second-highest number of weakest links in September, with 29. This sector is more vulnerable to cash flow disruptions amid high interest rates and inflation given its larger share of issuers rated 'B-' or below that have floating-rate debt. These highly leveraged companies have been struggling to generate adequate sustained free cash flow, and there is also execution risk, with labor costs weighing on these companies amid persistent personnel shortages.

In our base case, we expect this credit deterioration to slow in 2025 as inflationary pressures and labor costs continue to moderate after significantly challenging years in recent past. However, operating environments remain strained, requiring organizations to remain nimble, creative, and efficient to maintain profitability. Furthermore, defaults in the sector remain historically high.

The media and entertainment sector leads U.S.-based defaults through the third quarter with 17, after leading the count in 2023. It also had the third-highest number of weakest links in September, with 22. Slowing subscriber growth (caused by increased prices and budget cuts) is helping near-term profitability but at the cost of sustainable subscriber growth. In addition, sticky inflation and higher-for-longer interest rates may continue to weaken consumers' discretionary spending, especially for media.

While issuers in this sector refinanced large amounts of debt through the third quarter, helping to curb near-term risk, lower-rated companies ('B' or lower) with high leverage and weak competitive positioning continue to confront challenges in refinancing upcoming maturities.

Downgrades of speculative-grade issuers have increased since the start of the pandemic, and the share of issuers rated 'CCC' to 'C' has grown (see chart 12). However, following the increase in defaults in 2023, the proportion of these issuers has started to decline in the last nine months. These lowest-rated issuers have historically had a much higher default rate, and we expect them to remain stressed over the next few quarters.

Chart 11

How We Determine Our U.S. Default Rate Forecast

Our U.S. default rate forecast is based on current observations and on expectations of the likely path of the U.S. economy and financial markets.   In addition to our baseline projection, we forecast the default rate in optimistic and pessimistic scenarios. We expect the default rate to finish at 2.25% in September 2025 (37 defaults in the trailing 12 months) in our optimistic scenario and 5.25% (86 defaults in the trailing 12 months) in our pessimistic scenario.

We determine our forecast based on a variety of factors, including our proprietary analytical tool for U.S. speculative-grade issuer defaults.   The main components of the analytical tool are economic variables (the unemployment rate, for example), financial variables (such as corporate profits), the Fed's senior loan officer opinion survey on bank lending practices, the interest burden, the slope of the yield curve, and credit-related variables (such as negative bias).

In addition to our quantitative frameworks, we consider current market conditions and expectations.   Factors we focus on can include equity and bond pricing trends and expectations, overall financing conditions, the current ratings mix, refunding needs, and negative and positive developments within industrial sectors. We update our outlook for the U.S. speculative-grade corporate default rate each quarter after analyzing the latest economic data and expectations.

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