Fed's programs could lead to downgrades, defaults and bankruptcies
The Fed has not yet begun buying corporate bonds through its announced special facilities, but just by announcing plans to take action has sparked rallies in bonds across the spectrum and improved market functioning.
Yes, but: "The Fed’s aggressive actions have benefited the markets in the short term. Longer term, however, we think there will be downgrades, defaults, and bankruptcies, particularly among companies that came into the downturn with high leverage," warns Ruta Ziverte, head of fixed income for William Blair.
- With corporate debt markets again functioning smoothly, she expects to see a significant increase in bond issuance "as companies see their earnings decrease and sell more debt to raise funds," she says in a blog post.
- "We expect this to result in more downgrades ... across the full ratings spectrum."
What's happening: More than $120 billion of investment-grade bonds have been downgraded to junk status this year, and approximately $300 billion of the lowest-rated investment-grade bonds are on watch for downgrades or have negative outlooks, Ziverte notes.
- "We estimate that as much as $200 billion of debt (about 3.7% of the investment-grade market) could be downgraded over the next 12 to 18 months."