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The Defaults Wave is Rising

In the past couple of months, the rising rates have started to show an impact on the real world as the recent mortgage applications fell by -3.7% week on week basis. This is accompanied by high house inventory in the market not seen in recent times. Even the used automotive prices have fallen to the lowest level in one year.

All these are signs of demand correction exactly the requirement to bring inflation down and a win for central banks. But rising rates during a high inflation period has many negative effects before the desired results are achieved.

This double whammy to an average income earner results in them choosing what, how, and when to pay. In the USA there are almost 20 million consumers behind on their power bills. In the UK, many businesses are being forced to shut down as the new power contracts are three to four times the previous ones.

In this period of making such choices, the over-leveraged businesses and individuals are forced to look at the cash flow rather than profits. And as the focus reverts to the basics the loan repayments start to move lower in terms of priority. This results in a slow but steady increase in defaults across categories.

In USA, default rates during July have increased substantially compared to the previous three months' average. In the automotive loan category, it is 12% above the three-month average and the unsecured personal loan default rate is 3.41% the highest since March 2020. Even the credit card debt has increased to $980 Bn with a rise of $46 Bn during the second quarter, the largest since 1999.

All these trends are about to accelerate by year-end and next year. This would increase the risk of a financial crisis in midst of a recession that would impact slowdown much more deeply than estimated.


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