Moody’s Investors Service says it expects the number of corporate defaults to increase substantially in the coming year.

The rating agency indicates that it expects defaults among highly leveraged, illiquid firms to increase as a consequence of the decline in credit availability, evidenced by the spike in high-yield credit spreads over the last month.

“In the coming months we expect more defaults among the weaker corporate credits that have been kept afloat in recent years on a pool of market liquidity that is now drying up,” says Kenneth Emery, Moody’s director of Corporate Default Research.

Moody’s forecasting model indicates that the global speculative-grade corporate default rate should rise from its current level of 1.5% to about 3.5% over the next 12 months through July 2008 and to rise further to 4.5% by the end of July 2009. Over the next 12 months through July 2008, the speculative-grade default rate is expected to reach 4.0% in the US versus 2.5% in Europe, consistent with the lower average credit ratings found in the US.

The model further predicts that default rates in the US will be highest in the packaging, construction, consumer durables, and automotive sectors; whereas, in Europe, Moody’s expects default rates to be highest in the consumer durables, hotel & leisure, and wholesale & retail distribution sectors.

Moody’s projections are based on a newly developed model for forecasting default rates and rating transitions.

“Our revised default rate forecast is driven by the current distribution of ratings and recent rating changes among speculative-grade companies, as well as forecasts of macroeconomic variables,” says Albert Metz, Moody’s vice president and senior credit officer, who directed the development of the new model. He explains, “More optimistic or more pessimistic macroeconomic assumptions will translate into lower or higher default rate projections.”