What else seems to be an economy now immune to rising interest rates may raise a red signal in light of the rising number of U.S. business bankruptcies.
The latest in a spate of data showing the U.S. economy was not only resilient in the face of 18 months of harsh Federal Reserve rate hikes, but actually building up steam again, is news of accelerated service sector growth last month and another reduction in unemployment claims this week.
The changes have led to an upward revision in third-quarter U.S. national output estimates along with rising retail sales in July. This presents challenges for the Fed as it considers whether to cease its aggressive tightening campaign or wait for the adverse impacts to manifest gradually.
The heat of the recovery is causing bond markets to become uneasy. At the same time that significant government debt sales are taking place, headline inflation has risen by another tick, and yearly crude oil prices have turned positive once again for the first time since January.
But despite the astonishing strength of the mega-cap stock market bellwethers this year, the long-anticipated recession appears to be getting further away. There are some indications that the rate crunch is beginning to harm many small- and medium-sized firms.
The high-profile corporate collapse of transportation company Yellow Corp last month looks far from a unique occurrence, notwithstanding its peculiarities.
Epiq Bankruptcy, a company that tracks bankruptcy files, reports that there were 634 commercial Chapter 11 applications in August, up 54% from the same month last year and marking the 13th consecutive month of increases in both commercial and individual cases.
In response to the statistics, the insolvency research organisation ABI cited high interest rates, price inflation, and the restart of student loan payments as just a few of the stressors.
However, the annual rate of increase of that measure by June was at a rate not seen since 2010. This is according to official quarterly figures on total U.S. business bankruptcies in the 12 months to midyear.
S&P Global Market Intelligence limited the subset to businesses with a minimum of $2 million in assets and liabilities, and it discovered 64 new bankruptcies in July. This was the highest monthly total since March and the most single-month filings in either 2021 or 2022.
Additionally, it stated that the overall number of Chapter 11 filings in the first seven months of 2023 was higher than the total for the whole previous year and higher at that point in the year than any comparable period over the previous 13 years.
Albert Edwards, a strategist for Societe Generale, seized on the August Epiq bankruptcy data to highlight how unevenly American businesses were affected by what at first glance appeared to be a perplexing impotence in Fed policy.
This summer, Edwards and fellow SocGen strategist Andrew Lapthorne brought attention to what they call the “maddest macro chart”: a 30% annual decline in overall corporate net interest payments despite rising long-term borrowing costs and Fed policy rates.
This partially reflects the built-in resistance of households to rate increases associated with long-term fixed-rate borrowings and still-high cash savings that now earn much higher rates of interest.
But the apex of the tree is tilted towards public corporations with large cash levels.
Lapthorne demonstrated how the top 10% of the S&P1500 had an earnings-to-interest-payment ratio of 13 times, but the Russell 2000 small caps had just 2.5 times that ratio.
Furthermore, during the Fed campaign, there had been no increase in net interest payments for that 10%, which represents more than 60% of the index market value. It currently holds 70% of the total cash and is earning a respectable interest return.
According to the SocGen strategists, this has reduced overall U.S. profits by up to 20% in comparison to a typical tightening cycle and probably contributed to delaying the start of any recession.
It should come as no surprise that the Russell 2000’s relatively modest 5% annual return is only a third of the whole market.
Creeping insolvencies among smaller businesses, many of which have been branded “zombies” for years because they have survived primarily on low lending rates, could, however, be a more accurate indicator of what is taking place at the economic front lines.
“If you look just below the very large-cap stocks, the ‘old normal’ still applies with higher rates triggering a surge in corporate bankruptcies that will surely lay low the overall economy,” observed Edwards, a longtime equity market bear.
The flip side, of course, is that small firms, which employ the bulk of American workers and may control the strength of the labour market and, consequently, consumer spending, claim to be stabilising. Total bankruptcies also continue to be low despite the dramatic rise.
A monthly survey of small businesses by the National Federation of Independent Business showed confidence levels at their highest in eight months up until July, at least, even though the sector is still working to recover from last year’s devastation.
That was true even though the average interest rate paid on short-term loans to small firms soared to 9.2% in June, up 1.4 percentage points from May’s figure and the highest increase since December 2006.
The NFIB interviewed businesses, and 62% of them said they were not interested in a loan, while 25% claimed their credit needs had been satisfied.