Recession fears began as a whisper earlier this year, but quickly turned to a roar following the second consecutive negative quarterly GDP print in the U.S. While technically two quarters of negative economic growth do not indicate a recession—the National Bureau of Economic Research (NBER) defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months—there is little doubt at the headline level, our economy is slowing. For credit investors, this means the potential for a fresh default cycle. Rather than contribute to the will we/won’t we recession echo chamber, in this note, we assess what a potential default cycle could look like, what that may mean for valuations, and offer a framework for credit investors to assess whether they are being adequately compensated for these risks.
Key takeaways
- With recession fears taking hold, credit investors are weary of potential default scenarios.
- Using empirical data, we can estimate implied market default rates to ascertain whether credit investors are being adequately compensated for default risk.
- Historically, markets have overestimated actual credit defaults, meaning investors have received excess compensation for bearing default risk.
- Given overall market composition and healthy fundamentals, we do not expect credit markets to experience a severe default environment.
