Oaktree Capital Management has warned that many companies in the U.S. leveraged loan market could face significant distress in the coming year if the Federal Reserve continues to maintain high interest rates. The roughly $1.5 trillion leveraged loan market includes floating-rate debt that has been taken out by various companies. While on the surface, these companies may appear to be handling the interest rate changes well, storm clouds are beginning to emerge.
The team at Oaktree, led by co-chairman and chief investment officer Bruce Karsh, highlighted the challenges that elevated interest rates are posing for companies when it comes to servicing their floating-rate debt. Leveraged loans are considered speculative-grade floating-rate debt, but with rates only resetting a few times each year, which has provided some flexibility for borrowers who have not hedged against the Federal Reserve’s rate increases since 2022.
However, Moody’s Investors Service has revealed that approximately 62% of companies in the B- ratings category in the U.S. loan market would see their ability to pay interest on their debts fall below a key 1.0x coverage ratio if the Federal Reserve keeps its policy rate unchanged next year at the current range of 5.25%-5.5%.
The potential distress in the leveraged loan market can have significant implications for these companies and the wider economy. Late payments, insolvencies, and people falling behind on their payments can lead to a deflationary effect on the economy. Oaktree’s warning indicates that this process may already be underway, as they draw parallels to the occurrence of punishment in commodities.
Additionally, there are concerns about the global bond market, with record liquidation volume observed in the t-bond market this week. This lack of demand for bonds indicates that central banks may abandon their fight against inflation when the market starts to break down. The result could be severe consequences for stock gamblers who may suffer significant losses.
The Chinese property crisis and the stronger dollar have also put pressure on the embattled Yuan. During China’s Golden Week, the Yuan came close to reaching its band limit, indicating the impact of these factors on the country’s currency.
In conclusion, the U.S. leveraged loan market faces potential distress if the Federal Reserve maintains high interest rates. This could lead to late payments, insolvencies, and people falling behind on their debts. The global bond market is also showing signs of weakness, which may prompt central banks to abandon their fight against inflation. These factors, combined with the Chinese property crisis and the stronger dollar, pose significant risks to the economy and financial markets. Investors and businesses should closely monitor these developments as they could have far-reaching consequences.