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Corporate default rates are expected to surge in 2024 before easing in 2025, Fitch Ratings says.

In a new report, the rating agency forecasts that the high-yield corporate default rate will rise to between 5.0% and 5.5% next year, with the leveraged-loan default rate coming in at between 3.5% and 4.0%. That’s up from a 3.0%–3.5% range for both rates this year.

“Higher default rate expectations for 2024 reflect growing macroeconomic headwinds, including the impact of higher-for-longer interest rates and a sharp slowdown in the U.S. economy, as growth is expected to decelerate meaningfully in response to tighter monetary policy and its impact on consumer spending,” Fitch said.

Elevated interest rates are expected to erode companies’ free cash flow positions in the year ahead, with earnings growth slowing alongside the economy.

Fitch noted that many companies are already seeing their operating performance decline.

“In tandem with a slowing economy and tighter access to capital markets, this will lead to an increase in 2024 default volume,” it said.

For high-yield issuers, defaults are expected to rise as fixed-rate debt matures next year and issuers are forced to refinance at elevated interest rates, it noted.

In particular, sector-specific issues in the healthcare and pharmaceutical, telecom and technology sectors are expected to drive higher defaults, Fitch noted.

For instance, the tech sector “is facing weaker hardware demand as customers digest robust post-pandemic spending and supply chains continue to reduce excess inventory,” it said.

Telecom companies are at a higher risk of default due to the prevalence of elevated capital spending which constrains their ability to generate free cash flow and reduce leverage.

And, the healthcare and pharma sectors are facing challenges from rising labour costs, post-pandemic recovery challenges, and regulatory risks, it said.

Looking ahead to 2025, default rates are expected to drop back to between 2.0% and 3.0% as some of these pressures ease, Fitch said.

“Our lower default forecast for 2025 is driven by lower anticipated Fed rates and a slightly improved U.S. economy relative to 2024, with tighter monetary policy modestly dampening growth as the lags of the tightening cycle continue,” it noted.