Since the onset of the pandemic, the number of levered corporates in distress tracked by Debtwire has been trending down. It peaked at 196 in Q1 2020 and fell steadily until Q4 last year, when there were just 49 filings.

Then came 2022 and a slew of new challenges, from war in Ukraine to record-breaking hikes in inflation.

Does an uptick in distressed companies in Q1 spell the reversal of a trend? If so, what should corporates watch out for in the coming months?

1/ New pressures and uncertainty suggest these numbers could climb further

The Russian invasion of Ukraine compounded decades-high inflation by disrupting supplies and sending prices even higher. The European Central Bank has indicated that it will need to take prompt action, but credit markets have been taking care of that already, with yields and borrowing costs both rising. At the same time, economic headwinds are putting pressure on revenue and profit growth.

This is proving to be a problem.

In Q1 this year, the number of distressed leveraged loan and high-yield bond issuers climbed for the first time in two years, to 72 companies—more than 45% up on the previous quarter.

The retail sector always leads the pack, but the delta between the inflation-sensitive industry and others is now increasing. Nearly a third (31%) of distressed companies tracked are retailers, up from 23% as recently as Q3 last year.

Meanwhile, the services sector has seen its share of the distressed pool fall sharply, from 20% in Q4 to just 6% in Q1 this year. This coincides with COVID-19 infection rates passing their peak at the beginning of the year and then falling precipitously. Consumers are spending more on in-person activities and the market reflects that.

2/ Rising rates in the EU are inevitable—but at a slower pace 

Until Q2 data is finalised, it remains to be seen whether we are now entering a period of heightened distress.

There is no shortage of evidence to suggest that is the case. Everything boils down to inflation, the number one policy priority for central banks. The Bank of England and Fed in the US have already been tightening, with the latter hiking by 75bps last week, the biggest interest rise in the US since 1994.

The ECB has similar plans, but less room to manoeuvre. Last week, the bank's officials held an emergency meeting amid a resurgent sovereign debt crisis in the region. The ECB is anxious about Italy's widening bond spreads and what a sovereign default by the country could mean for the stability of the monetary union.

Ultimately, it needs to exit its stimulus and raise rates but doesn't want to upend the eurozone's weakest, most indebted economies in the process, so is developing an "anti-fragmentation" instrument.

But the writing is on the wall. Central banks have little choice but to tighten into a slowing economy.