US corporate defaults to rise on higher-for-longer funding costs, says Deutsche Bank

Deutsche Bank projects that the default rate for U.S. speculative grade companies will rise from 4.7% to 4.8% by the second half of 2026, driven by tight monetary conditions and the Federal Reserve's reluctance to cut rates amid inflation concerns. The bank anticipates the U.S. 10-year yield will soon exceed nominal GDP growth, excluding the pandemic period, and assigns a 30% probability to a recession, further contributing to the expected increase in defaults.

Analysis

Deutsche Bank projects an increase in the default rate for U.S. speculative grade companies, rising from the current 4.7% to an anticipated 4.8% by the second half of 2026. This forecast is attributed to either weakening economic growth or the persistent pressure of higher interest payments stemming from tight monetary conditions. The Federal Reserve's reluctance to implement rate cuts, driven by ongoing inflation concerns, is a key factor, with Deutsche Bank anticipating the U.S. 10-year Treasury yield, currently around 4.5%, to soon exceed U.S. nominal GDP growth for the first time since at least 2011, excluding the pandemic period. This scenario is compounded by a 30% probability of a U.S. recession, as assessed by the bank, and continued tightening of bank lending standards. Consequently, it is expected that either weaker economic growth or sustained higher interest rates will prevent a decline in U.S. corporate defaults in 2026, as the Federal Reserve is deemed unlikely to ease monetary policy significantly before observing job market deterioration.

Key Decisions for Investors

• Investors should exercise increased caution towards U.S. high-yield corporate debt exposure given the projected rise in default rates through H2 2026.
• Closely monitor leading economic indicators, particularly those related to GDP growth and employment, as well as Federal Reserve communications, to assess the evolving risk of recession and shifts in monetary policy.
• Consider stress-testing portfolios for the impact of sustained higher interest rates and tightening credit conditions, particularly for companies with significant leverage or refinancing needs in the near term.