As a decade of easy money and low interest rates came to an end, and with fears of a credit crisis seemingly receding, experts are advising that globally a wave of corporate bankruptcies may well come to pass. Top corporate debt experts are ringing the doom bells as they say apart from the early days of the pandemic, large corporate bankruptcies amounting to USD500 billion are accumulating at a pace second only to the global financial crisis in 2008.

Such experts suggest that the amount of corporate debt will continue to grow, straining credit markets that have been recovering from some of the biggest losses seen in twenty years and could threaten to slow economic growth. Many commentators just see the tip of the iceberg, as empty offices sprawl from Hong Kong to San Francisco, where many workers now work remotely from home. However, the underlying problem is debt built up throughout an era of cheap money, now costing much more to service as central bank’s monetary policy dictates increases in interest rates.

For example, in the United States from 2008 to 2021 the size of leveraged loans and high yield bonds, (owned by lesser creditworthy and riskier businesses) more than doubled to circa USD3 trillion. One interesting figure that has also been released for the time span 2008 – 2021 is that debts belonging to non-financial Chinese companies soared relative to the size of the Chinese economy. 

Elsewhere in Europe, in 2021 junk bond sales increased by circa 40%, a number of which are coming due for payment adding to the already outstanding debt of USD 785 billion that will have to be paid. In London, HSBC has its headquarters in Canary Wharf along with a number of other large financial institutions, where the once completely derelict site became a major financial centre. HSBC has already announced they are vacating the site in 2026 and prior to the Covid-19 pandemic banks were already scaling back on their working space. As a result, and not forgetting the impact Brexit had on office working spaces, two buildings in Canary Wharf owned by a Chinese property developer were seized by receivers due to non-payment of loans. 

In the world of private equity some of the companies they bought now have a debt level in excess of USD70 billion and are trading at distressed levels. For many years private equity enjoyed low interest rates and easy credit, and their business plan was to buy a company, then borrow money and then cut costs, thereby making a profit. Sadly, these companies were often left laden with debt, and more often than not with floating rate loans on the books. Like many companies throughout the world some private equity firms thought near zero interest rates would last forever, so they never bother to protect their companies with lost cost hedges. Today, with higher interest rates these companies are close to receivership.

As all these debts grow and more companies become distressed, other sectors such as advertising companies are affected, as this is the first area where companies reduce their budgets. Another sector feeling the pinch is real estate, where most of the distressed debt is related to the property problems in China, where companies such as Dalian Wanda Group have seen their debt price collapse and China Evergrande Group who have had to restructure their debt.

The collective global economy will have to hold their breath to see if central bank policies will allow for a reduction in interest rates as inflation is hopefully brought under control. However, with Russia having pulled out of the Black Sea Grain Initiative (implemented in July 2022), this may or may not negatively impact inflation, we will have to wait and see.

As inflation in the United States begins to cool, it is accelerating a decline in the US Dollar, which in turn is benefitting risk assets* across the globe. In September 2022, the US Dollar surged to a record high on the back of increasing interest rates, today against a basket of currencies the US Dollar is down circa 13%, its lowest levels for 15 months.

*Risk Assets as the words imply are those assets that carry a certain amount of risk and are quite susceptible to price volatility. Such assets are generally recognised as emerging markets, currencies, equities, commodities and high-yield bonds.

The global financial system is underpinned to a great extent by the US Dollar, so as the US Dollar declines, so US Treasury yields ease, making the US Dollar less attractive. However, on the other side of the coin, this gave a boost to foreign currency across the board such as the Mexican Peso and the Japanese Yen.

From a corporate standpoint, some US companies will benefit from a weaker dollar as this will allow multinationals to convert overseas profits back to dollars more cheaply, whilst at the same time making exports more competitive in overseas markets. For example, in the US technology sector, where some companies are enjoying high growth and have recently led the markets higher, they have, according to experts, generated circa 50% of their revenue from overseas markets.

In the currency world, throughout the foreign exchange markets, as the US Dollar declines technical levels are being broken, and across the globe those currencies that are risk-sensitive are ticking up. Certain foreign exchange strategies will benefit from a falling US Dollar such as a Dollar Funded Carry Trade*. Experts in the dollar funded carry trade market expect these trades to thrive against a bleak outlook for the US Dollar. 

*A Dollar Funded Carry Trade is where a higher yielding currency is bought against the sale of US Dollars, allowing the participant to pocket the difference.

The fall in the US Dollar will be a boon to some central banks and their monetary policies as they can withdraw support for their own currencies. In Japan for example, the US Dollar has fallen by 3% in the week ending 14th July and has dented expectations that as an import reliant economy, the government would have to intervene in the currency markets.

Figures from the S&P Goldman Sachs Commodity Index (S&P GSCI) have ticked up 4.6% this month reflecting the declining dollar reflecting raw materials being more attractive to foreign buyers. Emerging Markets are also benefitting from a fall in the US Dollar, making any debt corporate or sovereign easier and cheaper to service. This has been reflected in a 2.4% increase this year in the MSCI Emerging Market Currency Index.

The outlook for the US Dollar is essentially very bearish with many experts predicting the currency will fall to levels before the Federal Reserve started hiking interest rates and may go even weaker. But bears beware, a sudden unexpected increase in inflation could change strategies across the globe.

Whilst the United Kingdom still struggles to keep inflation in check, inflation surprisingly fell to 5.5% in the Eurozone, down from 6.1% in May, which is the lowest since January 2022. However, before policymakers could start popping champagne corks, the mood was tempered as figures showed a small uptick in core consumer price growth, with core inflation (excludes food and energy) having increased from 5.3% in May to 5.4% in June. This was clearly a disappointment for the ECB (European Central Bank), as until the underlying price pressures fall to the target of 2%, the ECB has confirmed they will keep raising interest rates.

Meanwhile, in the United Kingdom, contrasting figures with the Eurozone show inflation at the end of May at 8.7%, and with the Bank of England raising interest rates by 50 basis points on 21st June, there are fears that in order to keep battling inflation, a subsequent rise of the same amount is in the offing. Furthermore, recently released figures show that amongst the G7 countries, the United Kingdom’s growth rate for Q1 was the slowest (apart from Germany) and as of May, the annual inflation rate of 8.7% was the highest.

Experts point to emerging differences between the United Kingdom and the Eurozone, where the ongoing shortages of labour, plus the energy price crisis, make for a toxic combination resulting in inflation being more stubborn to shift than the Eurozone and other G7 countries. 

Regarding labour shortages, there are a record number of job vacancies, and the United Kingdom is facing additional inflationary pressure as companies across the land increase salaries/wages in attempts to fill these vacancies. Post-Brexit immigration laws are cited as one reason for a declining labour market, whilst post the Covid-19 pandemic, there are record levels of long-term sickness amongst adults of the working age.

Expert analysts also point to the United Kingdom’s governments Energy Price Guarantee (EPG), where for a typical household, electricity and gas bills have been capped at £2,500 pa (1st October 2022 – 1st July 2023). However, similar caps were not introduced in the Eurozone, therefore the recent decline in global wholesale electricity and gas prices are better reflected in their current inflation rate.

Furthermore, economists suggest another divergence between the Eurozone and the United Kingdom is that the UK’s economy is more service based than manufacturing based as opposed to those economies in the Eurozone. This leads to a more balanced economy which is reflected in the fact that inflation across the Eurozone is declining (apart from Germany and Croatia) whereas the United Kingdom is struggling on the inflation front. 

Figures for the end of July will show if this divergence is continuing, however, within the ECB’s rate setting council members have acknowledged that criticism by members of the UK press regarding the Bank of England’s handling of inflation, has served as a cautionary warning to the wise.

As recently as last week, core inflation (excludes energy and food prices) in both the Eurozone and the United States was easing slightly, whilst in the United Kingdom inflation remained 8.7%, but core inflation increased to 7.1%, the highest since 1992. So why is it when the United States and the Eurozone get a drop off in core inflation, Great Britain suffers an increase?

Without a doubt all Remainers blame Brexit for the inflation problems with the ex-governor of the Bank of England, Canadian Mark Carney, being their standard-bearer. The fall in the pound after Brexit is usually trumpeted as a reason for inflation, but that was seven years ago, and since then, sterling, apart from the odd blip (the Liz Truss regime stands out), has remained relatively steady and in 2023 has gained in strength.

Other reasons from the Remainers camp is trade with Europe is now more expensive and difficult with the end result being costlier imports. The lack of access to labour and skilled workers from Europe is yet another reason put forward by Remainers, but with immigration actually having increased this argument is redundant. However, it cannot be denied that leaving Europe has contributed to the weakness in business investment, but is that a contributing factor to an increase in inflation? Probably not.

The Bank of England has received many derogatory comments regarding the increase in core inflation, and it is argued that their attitude towards inflation was lethargic, and they are therefore responsible for the problems that beset the nation today. Blaming the Bank of England is the easy way out, and they have acted in concert with many other central banks throughout the world. In fact, they were the first to raise interest rates.

Experts suggest that there are a number of influential factors responsible for the increase in core inflation and these can be seen in;

1. Pay Inflation – The United States is running at 4.3% and the Eurozone is running at 5.2%, whilst in the United Kingdom it is running at 7.2%, helped along by increasing the National Living Wage in 2022 by 6.5% and by 9.7% a year later.

2. Supply Performance – The United Kingdom is suffering from a poor supply performance, and as opposed to other G7 countries their GDP is still well below pre-Covid-19 levels.

3. Workforce – There has been a massive fall-off in the workforce, with Covid being the major instigator of this scenario, but Covid was a global shock that has left its mark and can take some responsibility for where the United Kingdom (and many other countries) are today.

The United Kingdom is not alone in fighting inflation, and according to experts, the root cause of the massive increase in global inflation is found in a series of supply shocks, resulting in higher prices and the probability of a wage – price spiral. Central Banks would have to use monetary policy to fight this spiral, with the end result of bringing down inflation and hopefully wages. 

Sadly, the United Kingdom was hit particularly badly as the supply situation was much more severe than many other countries, and this is the real criticism of the Bank of England, as they did not act quick enough to keep the lid on the wage – price spiral.

There is only one monetary supply policy available to the Bank of England, and if increasing interest rates is the only way to fight inflation, the United Kingdom may well fall into recession. It will be painful, but we can only hope the current policy will bring down inflation at a faster rate than is currently predicted.

Despite the fact the economic outlook looks gloomy across the European Union, the low valuations of European small and mid-cap stocks have caught the eye of many an investor, as their relatively low valuation has ignited long-term interest. Whilst recent banking upheaval promoted thoughts of a credit crunch, and recent anxieties regarding an economic slowdown favoured “defensives over cyclicals” *, the smaller European companies have seen valuations sink.

*Defensive stocks are those companies that are recognised to have defensive earnings, that do not really equate to the economic cycle. Such companies usually supply necessities that consumers will not cut back in times of a downturn in the economy. These necessities are typically power, such as electricity and gas, healthcare and certain foodstuffs. 

 *Cyclical stocks are those companies that are recognised as being more exposed to the economic cycle. Thus, when economic conditions are on a downward cycle, these companies are likely to see a drop off in earnings, but if economic conditions are on an upward cycle, then conversely earnings will increase. Such companies are recognised as being in the travel, construction and luxury goods sector.

Many European focused investors suggest that while the current economic slowdown persists, the current price of SMIDs (Small-Mid Capitalisation), have already had much of the risk factored into their price. The thinking therefore is that should Europe enter into a prolonged recession, SMIDs will have less downside than the larger companies or stocks.

In the AI (Artificial Intelligence) sector, breakthroughs in generative AI (algorithms that can be used to create new content such as images, text, simulations, video and audio), have in recent months kept investors focused on mega-stocks. However, from an AI angle those SMIDs that have available resources to invest in AI will hold an advantage over those who lack the same resources.

Expert analysts suspect that European economic data will get worse over the next three months especially as data recently released shows the EuroZone suffering from a technical recession, where there has been negative growth in real GDP in two consecutive quarters. When the data shows an economic upswing across the EuroZone, the revival of small caps will begin, and the same analysts suggest that this will provide a rich hunting ground for those long-term focused investors.

On Thursday 22nd June 2023, defying market predictions, the Bank of England put up interest rates by a full half percentage point, to 5%, the highest level since 2008. Both the Prime Minister Rishi Sunak and the Chancellor of the Exchequer Jeremy Hunt backed the Bank of England to the hilt, confirming Andrew Bailey’s (Governor of the BOE) uncompromising attack on inflation. 

Apparently recent data showed that there were stronger inflationary pressures on the UK economy, thus the Bank of England’s Monetary Policy Committee (MPC) voted seven to two to increase interest rates by 0.5%. The Bank of England is committed to their policy of reducing interest rates to 2% by raising interest rates 13 times since December 2021.

The Bank of England’s expectation that inflation would fall in May failed to materialise with inflation staying at 8.7% well beyond and above the intended target of 2%. Many experts and analysts are suggesting that the rate rises are doing more harm than good and figures confirm that inflation in the UK is the highest of any G7 country.

Such interest rate increases have pushed lenders to reprice their “Fixed Rate” mortgage deals pushing up prices whilst at the same time putting increased pressure on homeowners, which may result in a swathe of repossessions. The Chancellor, having already announced there will be no help for homeowners, did a u-turn on Friday and announced an agreement with lenders where homeowners struggling with repayments would be given a 12 month grace period before any repossessions take place. This agreement encompasses mortgage holders extending their current agreement or moving to an interest only plan.

Due to interest rate increases, the circa two million mortgage holders on tracker rates have seen their monthly outgoings rise every six weeks since December 2021. UK data shows that there are six million households tied to fixed rate mortgages with 800,000 due at the end of the year 2023. We can only hope the Government’s and the Bank of England’s monetary policies can finally start to eat away at inflation avoiding a mortgage time bomb at the end of 2024.