Recessions usually come from a series of dominoes falling: the housing market crashes, the tech bubble bursts, and so on.
Right now one of the biggest sources of fear is the credit market.
As oil prices have collapsed, the fear that energy companies would go bankrupt and that any negative impacts from this would spill into the broader economy has risen.
And according to Michelle Meyer, US economist at Bank of America Merrill Lynch, the fear of contagion from bankruptcies in the energy sector to a broader economic slowdown is just that — a fear.
“It is important to note that if defaults rise due to non-macro events — which means without being triggered by a recession — there seems to be somewhat limited feedback into the economy,” said Meyer in a note to clients on Friday.
This basically means that the bankruptcies from energy companies are not in and of themselves problematic. Investors should be far more worried if a slowdown in the economy away from just a decline in oil prices were triggering these bankruptcies.
According to Meyer, high yield bond defaults will reach 6% this year. And even if that leads to layoffs at those companies, the tremors won’t be enough to knock the economy off its solid footing.
If we assume the companies who default are average size, this would mean that 600,000 workers are vulnerable. However, many bankruptcies result in restructuring rather than the demise of the company, suggesting a portion of the workforce would likely be retained.
For argument’s sake, let’s say half of the workers in companies going through bankruptcy proceedings become unemployed over the course of a year. This would result in 25,000 job cuts a month. As we have seen in the energy sector, a lot of these layoffs may already be happening so the incremental layoffs would presumably be less than 25,000 per month.
This is clearly just illustrative and assumes that bankruptcies are narrow and do not spread to the broader economy.
And so with recent economic data indicating an economy that — while not doing great — is still growing, defaults seem likely to have a limited broader impact.
According to Mark Durbiano, senior portfolio manager of high yield debt at Federated Investments, the worry over contagion showed up in a sell-off of high yield bonds to start the year, and current moves, however, show the risks have faded.
“People were looking at energy as a microcosms of the whole debt and credit market,” Durbiano told Business Insider.
“It really was just an industry-focused event. Corporate credit quality is solid, the US economy is solid, there’s no reason to think that’s going to change anytime soon.”
Durbiano, who oversees $51.1 billion in fixed income funds, said that the likelihood of contagion is incredibly low and he thinks there is little risk from either increased defaults or tightening bond lending standards more broadly.
Meyer is of the same view.
Outside of the direct negative effects such as layoffs and bankruptcies, Meyer doesn’t see the defaults making much of an impact on companies taking out loans, thus doing little to slow investment behaviour and general economic growth.
“While it is still early, there is little evidence of bank credit tightening thus far,” wrote Meyer.
“[Commercial and industrial] loans utilised continue to grow at around 10% yoy, based on the Fed’s aggregate H8 data. Our internal data show that Bank of America domestic C&I loans are growing at a solid pace…This implies that both supply and demand of credit are increasing, implying we are not seeing higher utilization rates that would signal greater stress.“
Business Insider Emails & Alerts
Site highlights each day to your inbox.