Leading Credit-Risk Indicator Signals a Rising Default Rate
The month-long average for the expected default frequency metric of U.S./Canadian high-yield issuers climbed from August 2018’s 2.38% and July 2019’s 4.16% to 4.59% in August. The ascent by the highyield EDF was joined by a widening of the high-yield bond spread’s month-long average from August 2018’s 354 basis points and July’s 422 bp to August’s 468 bp. Since the statistic was introduced in January 1996, August marked the fourth time the high-yield EDF metric’s month-long average increased sequentially to at least 4.59%.
The previous occurrences and the accompanying high-yield bond spreads were August 2015 (568 bp), August 2008 (800 bp), and August 1998 (469 bp). Given the near equivalence between the high-yield bond spreads of August 2019 and August 1998, the bond market senses that any forthcoming increase by the default rate will be well contained. Both the high-yield bond spread and the high-yield default rate increased significantly by the ninth month following the three incidents. For example, the increase by the high-yield default rate from August 2015’s 2.3% to May 2016’s 5.5% coincided with a widening of the high-yield bond spread from 568 bp to 632 bp. Similarly, the default rate’s surge from August 2008’s 3.2% to May 2009’s 11.0% was accompanied by a widening of the high-yield spread from 800 bp to 1,189 bp. By contrast, the increase by the default rate from August 1998’s 2.6% to May 1999’s 4.65% was joined by a comparatively mild widening of the high-yield spread from 469 bp to 513 bp. As inferred from the statistical record, August’s high-yield EDF metric of 4.59% favors an increase by the default rate from a recent 3% to 4% by May 2020. Nevertheless, it is possible that enough improvement in the outlooks for cash flows and pretax profits could prevent a significant widening by the high-yield bond spread from Tuesday’s 465 bp
