The Strategist

S&P warns of rising asset price inflation

07/06/2020 - 06:14

A fifth of those companies whose ratings are calculated by Standard & Poor’s agency have already faced their decline. Moreover, as analysts at the agency warn, the impact of the COVID-19 pandemic on creditworthiness will be felt in individual sectors until 2023 and will lead to a marked increase in the number of bankruptcies. At the same time, it will be increasingly difficult for central banks to tighten monetary policy due to growing debt burden. This, in turn, poses a threat of an unjustified rise in asset prices in the financial markets and an increase in demand for speculative debt.
A pandemic and its associated crisis will be affecting creditworthiness of companies and governments until 2023, analysts at the Standard & Poor’s international rating agency wrote in its latest report. Pressure on the ratings is exerted by a drop in revenues, while the debt burden is growing: companies are actively borrowing to cover the emerging deficit (in the US, the volume of placed bonds has already exceeded the figure for the entire last year - $ 956 billion - as of June 25).

The agency expects a 3.8% reduction in world GDP this year and a 5.3% increase in the next year, but the recovery will be extremely heterogeneous among different regions and countries, depending on how successfully the authorities fight with the spread of the virus and its consequences. In countries that have experienced the outbreak of COVID-19 early (in particular, China, Australia, South Korea and New Zealand), the recovery will be faster than where the pandemic is just unfolding: this applies primarily to countries in Latin America, India and Indonesia, which will face a more pronounced drop in output and its slower return to pre-crisis levels. In the "middle" category were countries where the peak of the epidemic has already passed: the eurozone countries, the UK, the USA, Japan, Russia and Turkey.

In the USA, the agency expects a 5% decline, in the euro area - by 7.8%. Both forecasts are very soft even compared to official estimates and the forecast of the International Monetary Fund. However, in the corporate sector, the default rate among companies with speculative ratings by March 2021 may reach 12.5% in the United States and 8.5% - in Europe. This, in turn, will put pressure on banks; risks will increase for securities backed by assets. Air carriers, as well as business in the tourism sector - in particular, ship cruises - are unlikely to return to their previous levels until 2023. The crisis will also require fundamental changes in sectors such as the auto industry and retail. Only 21% of non-financial companies rated by the agency have already experienced lower credit ratings.

The level of public debt will also increase: direct and indirect support in the G7 countries is now approaching an average of 18% of GDP. The issue of such debts is now 52% higher than the base level. Households, on the other hand, can increase debts due to falling employment.

Moreover, due to the already growing debt burden, central banks will encounter difficulties in raising rates. It means that they will remain extremely low for a long time, which is a problem for banks, insurance companies and pension funds. At the same time, a higher level of uncertainty is likely to hit capital investments; as a result, monetary easing will lead to higher asset prices that are not justified by fundamental indicators. Thus, the demand for securities rated B in June was the highest in the last three years. Total speculative debt in the United States issued since the beginning of the year at $ 172 billion compared to $ 216 billion for the entire previous year.