NEW YORK June 2, 2025: On a flight home last week, since the seat pitch made it impossible to type on a laptop, I watched the movie about Bob Dylan,” A Complete Unknown.” Perhaps that’s why looking over market movements this month brought to mind the lyrics from his 1965 song “Subterranean Homesick Blues”: “You don’t need a weatherman to know which way the wind blows.” And you don’t need a risk manager to tell you if defaults are rising.
In keeping with the meteorological theme, all hurricanes start as tropical disturbances. Once the disturbance becomes more organized and if certain other conditions are in place, it can strengthen into a tropical cyclone. In the financial world, we worry about whether conditions are right for market disturbances to become a regime change, rather than simply an increase in volatility that will go back down over time. While our 3-Year Median Default Probability by Sector analysis shows all sectors swinging into the green (Table 1), a deeper dive into the consumer discretionary sector shows a slight uptick in the default probability for leisure products (Table 2).
So which market disturbances should be more closely watched? Despite almost daily whipsaw, everyone is tracking the status and modeling the impact of tariffs and their impact on supply chains, shipping, and inflation. Inflation and inflationary pressures are monitored just as closely. But one disturbance that should attract more scrutiny is what happened this month in the “Long JGB trade” — and more critically, what is happening across the globe in sovereign long bonds.
A hallmark of the post-1990 Japanese low- interest landscape has been the investment in long- duration Japanese Government Bonds (JGBs), with many banks borrowing short-term and purchasing long-term JGBs. However, earlier this month, a 40-year auction of Japanese debt drew the lowest demand in quite some time, creating concerns about the world’s third- largest bond market. The Japanese Ministry of Finance and Bank of Japan helped stabilize the market by insinuating that the long bond supply could be reduced. But the issue is not supply; it is a lack of demand. Moreover, the bigger issue is that the problem is not confined to Japan. Demand for long government bonds is down and yields are up in the U.K., France, Australia, Italy, Germany, and the U.S. (listed in the order of magnitude of yield jump over the past month).
If you accept that we are seeing a global supply chain realignment, adjusting to it will take significant investment, both from the private sector and the government, which will need to restructure trade and manufacturing infrastructure. Naturally, it makes economic sense to lock in low long-term rates for these investments. The increase in rates in Japan will drive reduced holdings in U.S. Treasuries based on relative yields, as well as reduced holdings by China for political reasons. During the month, Moody’s downgraded the U.S. debt rating to Aa1, aligning with earlier actions by S&P and Fitch. With U.S. debt standing at $36.8 trillion–123% of GDP– and annual payments surpassing $1 trillion, this is not a good time to see weak demand driving up long- term rates and pushing the Treasury to fund itself short-term.
Most defaults that have occurred have been idiosyncratic, based on excess leverage, poor management, or investment in speculative firms. Systematic failures have come about from technological advances, such as the “Ozempic revolution” or AI, but have been narrow in scope. The falloff in demand for long duration sovereign debt is a market disturbance that should be followed and modeled, as it poses a risk of transmission to all corners of the capital markets if other conditions are present. Regulatory or policy missteps or overreaction to unrealized losses on bank balance sheets are just two examples of how this one relatively arcane corner of the bond market could become more than just an increase in volatility. Clearly, institutions can hedge the idiosyncratic risk through strong portfolio management and prudent concentration limits. The systematic risk of steepening yield curves and changes in investors’ bond term preferences, as well as foreign exchange implications from actions in the government bond market, require robust stress testing from both a scenario- and a stochastic- based testing regime.
Table 1: Change in 3-Year Median Default Probability by Sector – December 31, 2024 – May 28, 2025
Source: SAS Institute KRIS data service
Table 2: Change in 3-Year Median Default Probability- Consumer Discretionary – December 31, 2024 – May 28, 2025
Contemporaneous Credit Conditions
The Kamakura Troubled Company Index® closed the month at 8.43%, down 0.60% from the prior month. The index measures the percentage of 42,500 public firms worldwide with an annualized one-month default probability of over 1%. An increase in the index reflects declining credit quality, while a decrease reflects improving credit quality.
At the end of May, the percentage of companies with a default probability between 1% and 5% was 6.6%. The percentage with a default probability between 5% and 10% was 1.24%. Those with a default probability between 10% and 20% amounted to 0.73% of the total; and those with a default probability of over 20% amounted to 0.30%. For the month, short-term default probabilities ranged from a low of 8.18% on May19 to a high of 9.11% on May 1.
Figure 1: Troubled Company Index®, May 30, 2025
At the end of May, the riskiest 1% of rated public firms within the coverage universe as measured by 1-month default probability included eight companies in the U.S., two in Canada and one in China. QVC Group, Inc (NASDAQ:QVCGA) remained the riskiest rated firm in our universe, with a 1-month KDP of 44.61–down 1.33% over the past month.
Table 3: Riskiest Rated Companies Based on 1-month KDP, May 30, 2025
The Expected Cumulative Default Rate, the only daily index of credit quality of rated firms worldwide, shows the one-year rate of 0.57% down 0.07% from the prior month, with the 10-year rate down 0.35% at 7.77%.
Figure 2: Expected Cumulative Default Rates, May 30, 2025
About the Troubled Company Index
The Kamakura Troubled Company Index® measures the percentage of 42,500 public firms in 76 countries that have an annualized one-month default risk of over one percent. The average index value since January 1990 is 13.99%. Since July 2022, the index has used the annualized one-month default probability produced by the KRIS version 7.0 Jarrow-Chava reduced form default probability model, a formula that bases default predictions on a sophisticated combination of financial ratios, stock price history, and macro-economic factors.
The KRIS version 7.0 models were developed using a data base of more than 4 million observations and more than 4,000 corporate failures. A complete technical guide, including full model test results and key parameters, is provided to subscribers. Available models include the non-public-firm default model, the U.S. bank model, and the sovereign model.
The version 7.0 model was estimated over the period from 1990, through the Great Recession and ending in February 2022. The 76 countries currently covered by the index are Argentina, Australia, Austria, Bahrain, Bangladesh, Belgium, Belize, Botswana, Brazil, Bulgaria, Canada, Chile, China, Colombia, Croatia, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Ghana, Greece, Hungary, Hong Kong, Iceland, India, Indonesia, Ireland, Israel, Italy, Japan, Jordan, Kenya, Kuwait, Luxembourg, Malaysia, Malta, Mauritius, Mexico, Nigeria, the Netherlands, New Zealand, Norway, Oman, Pakistan, Peru, the Philippines, Poland, Portugal, Qatar, Romania, Russia, Saudi Arabia, Serbia, Singapore, Slovakia, Slovenia, South Africa, South Korea, Spain, Sri Lanka, Sweden, Switzerland, Tanzania, Taiwan, Thailand, Turkey, the United Arab Emirates, Uganda, the UK, the U.S., Vietnam and Zimbabwe.
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Editorial contacts:
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