Corporate default rate expected to jump 30%

The U.S. corporate default rate is expected to jump 30% and hit 5.6% by June 2017, according to a jarring warning issued by credit-rating firm S&P Global Fixed Income Research.

Financial stress applied mainly by falling oil prices is "a driver of defaults" and why 99 U.S. companies with the lowest credit ratings could default during the 12 months ended June 2017. That would be dramatically higher than the 79 U.S. companies that defaulted in the 12 months ended June 2016, which resulted in a 4.3% default rate, S&P Global says.

Much of the pain is in the energy sector. Stocks in the energy and natural resources industries have accounted for 57% of defaults the past 12 months, S&P says.

The latest default forecast, based on S&P's most likely scenario, is in stark contrast to the bullishness expressed in the stock market. The Standard & Poor's 500 has jumped more than 8% this year and is nudging up against record highs.

While defaults are likely to rise, investors continue to be bullish on bonds as well as stocks. The difference between the yield on bonds with the lowest credit ratings and those with higher ratings fell to 5.6 percentage points. That's down from a 8.15-point difference in mid-February. This falling "spread" means investors are pouring money into the most speculative bonds looking for yield and are willing to accept a lower premium for the risk they are taking.

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Part of the strength in speculative bond prices is a function of the tight supply. Just $171.8 billion in speculative-grade new bonds were sold in the 12 months ended July 2016, down 22% from 2015's level and off about a third from the average issuance over the past three years.

The uptick in defaults is expected even as borrowers have gotten several unexpected boosts. The Federal Reserve seems to be in no hurry to raise short-term interest rates, which "should help keep borrowing costs subdued for most corporate borrowers in the U.S. as investors' search for yield guides them toward speculative-grade bonds," the S&P report says.

U.S. borrowers could also enjoy an unexpected boost due to the United Kingdom's decision to exit the European Union. S&P says. Bonds issued by U.S. companies "may be seen as less risky than their European peers," the report says.

And if there's a bright spot, defaults even next year are likely to be a fraction of where they were in the financial crisis. The credit pain is also centered mostly in the energy sector, and there "has been little spillover effect to other sectors." But S&P warns: "We are not ruling out this possibility in the coming quarters."