Inflation rears its head, geopolitical crises worsen, European businesses risk entering stormy waters. With the risk of taking the books to court. The bankruptcy rate for European speculative-grade companies, according to S&P Global, is seen at 3.5% for 2024, in line with last December’s estimate. But the Red Sea crisis and the skirmishes between the United States, China and Russia can act as a detonator for slowdowns in the production chain and therefore for company liquidity. In the adverse scenario, the crash rate will be 5%. A picture that is not so remote, S&P explains. Among the sectors most affected are those linked to high consumption products, followed by chemicals and healthcare. An aspect that cannot be ignored by the European Central Bank (ECB) in defining its next moves.
A year and a half after the first interest rate increase by Frankfurt, and 450 basis points of increase in the cost of money later, the first signs of entrepreneurial instability are starting to arrive. If it is true that the peak of inflation in the euro area was reached last autumn, it is equally true that persistence is still high. Which is why, according to the dominant thinking within the Frankfurt institution led by Christine Lagarde, it is more likely that the first easing of rates will take place in late spring, if not at the beginning of summer. The data illustrates a growing underlying uncertainty, mainly for reasons exogenous to the eurozone. Above all, the two full-blown wars: in Ukraine and in the Middle East. Then, an unexplained war, namely the one over the supremacy of space, in which Washington is in conflict with Beijing and Moscow. The unknowns are such that they make it difficult to calculate the possible insolvency procedures of European companies. Even for a rating agency like S&P Global.
By the end of 2024 the failure rate is expected to be around 3.5%, in line with the December forecast. But there could be an acceleration during the summer. The issue is that it is not known what the landing strip of the euro area economy will be. “A prolonged slowdown in growth (or recession), especially if triggered by a significant worsening of regional conflicts that extend to Europe, could push the default rate higher, to 5% in our pessimistic case”, explain the analysts Nick Kraemer, Paul Watters and Sarah Limbach. For many businesses and families, they point out, “burdens related to higher interest rates still lie ahead, despite recent market optimism and the decline in fixed rate yields.” On this last point, the upcoming maturities this year and next “will force issuers to deal with market rates that are still around 2% higher than those on existing debt”.
The basic picture, net of the deterioration of the Red Sea crisis (and therefore of logistics through the Suez Canal). predicts a stabilization compared to what has been seen over the past 12 months. S&P Global highlights this clearly: «Our expectations for 2024 focus on an economic scenario undergoing a soft landing, supported by wage growth and disinflation. Additionally, speculative-grade bond and loan markets have opened up in recent months, allowing companies to revalue and refinance existing debt.” That said, however, “expectations for more growth-oriented use of debt, such as mergers and acquisitions (M&A) and capital spending, remain modest for now, reflecting a still selective investor environment and restrictive interest rates.”
The impact of tensions in the Middle East remains the greatest unknown. To such an extent that the most optimistic scenario, which sees a decline in the bankruptcy rate to 2%, is only possible if deflation continues at a rapid pace, a factor that would give room for maneuver to central banks, the ECB and the Federal Reserve, for the first cuts at the cost of money. A picture not considered as the central one in the short term, S&P Global experts point out.
On the opposite side, there is the more negative picture. “Our growth expectations for most of Europe next year indicate some strengthening, but still below-average growth,” they explain. In addition to rising real rates, “speculative-grade issuers are vulnerable to an economic downturn.” And the data from the European Commission, which has worsened for the third time in a row, do not exclude such a picture. According to S&P, “under a scenario of even slower economic growth or recession, or if interest rates remain high through 2024, the default rate could rise to 5%.” Double that of January 2020, therefore pre Covid-19, and a point and a half more than in December just ended.
Even in this case, the reasons are to be found in ongoing conflicts. “The slowdown in earnings for several consecutive quarters leaves less room for maneuver in a high interest rate environment,” it notes. It follows that “issuers must meet refinancing needs, but at a higher cost”. The continuation of the conflict between Russia and Ukraine remains “a factor of further uncertainty, which could lead to more acute stress as winter approaches”. Furthermore, “the latest war between Israel and Hamas carries the risk of spreading to become a broader regional conflict, further putting a strain on regional trade and financial market sentiment.” A double crisis front, with possible implications on other geopolitical fronts, which scares both S&P and the ECB.