High Yield Credit Spreads Forecast to Widen as Investors Re-Price Risk
New York, NY – Amidst the US Federal Reserve’s consideration of ending its quantitative easing program, almost half the respondents to the latest IACPM’s Credit Outlook Survey forecast rising default rates and widening high yield credit spreads. The Aggregate Credit Default Outlook Index moved to negative -35.6 from minus -7.6. Survey respondents note, however, any rise in defaults comes against a backdrop of extremely low default rates, so an increase would be a return to more normal conditions.
“Defaults have been almost zero as central banks have poured liquidity into the financial system,” commented Som-lok Leung, Executive Director of the International Association of Credit Portfolio Managers. “Even extremely challenged companies have been able to get financing in the current environment. If and when, the banks start removing liquidity, struggling companies will have a considerably harder time rolling over their debt.”
There are global differences in the default outlook, to be sure. Europe remains the most vulnerable in the eyes of survey respondents, while North America is relatively neutral, with only a slightly negative outlook. Asia and Australia, though, are now seen as more susceptible to increasing defaults. The outlook for corporate defaults dropped in Australia from negative -8.3 at the end of March to negative -40.0 in the latest reading. Asia declined from minus -7.7 in March to -43.8 in the current survey.
“In terms of Asia and Australia, we began to see a change in sentiment between the December survey and the one taken March,” said Mr. Som-lok. “But the trends accelerated in the most recent reading as respondents reassessed the outlook for the next twelve months. The trends for the US and Europe, on the other hand, have generally remained the same over the last few surveys, especially for Europe.”
The credit outlook survey is conducted among members of the International Association of Credit Portfolio Managers, which is an association of credit portfolio managers at 87 financial institutions located in 17 countries in the U.S., Europe, Asia, Africa and Australia. Members include portfolio managers at many of the world’s largest commercial banks, investment banks and insurance companies, as well as a number of asset managers. Members are surveyed at the beginning of each quarter.
Survey results are calculated as diffusion indexes, which show positive and negative values ranging from 100 to minus -100, as well as no change which is in the middle of the scale and is recorded as “0.0.” Positive numbers signify an expectation for improved credit conditions, specifically fewer defaults and narrower spreads, while negative numbers indicate an expectation of deterioration with higher defaults and wider spreads.
The outlook for credit spreads in the current survey show a clear differentiation between investment grade and high yield debt. Investment grade debt is relatively unchanged in North America, falling from a slightly positive reading in March of 4.3 to a marginally negative -2.2 in the latest survey. The outlook for investment grade debt in Europe actually improved somewhat from minus -12.8 in March to negative -7.7 now.
The forecast for high yield credit spreads, though, dropped sharply. In North America, the outlook dropped from 0.0 in March to minus -20.9 this quarter, while the outlook declined in Europe from minus -8.3 to negative -24.3.
“Respondents clearly believe high yield debt will be re-priced in the near term in the form of wider credit spreads, while the results would also indicate they think investment grade debt is adequately priced,” said Mr. Leung. “The outlook is hardly surprising, though, given that high yield is moving off of relatively deep lows and is, in fact, continuing a trend we saw beginning at the end of December. Investment professionals expected a change in market conditions which has probably become more pronounced in the wake of the Fed’s current deliberations.”
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The IACPM, with 87 member institutions located in 17 countries, is a professional association dedicated to the advancement of credit portfolio management. Founded in 2001, the organization’s programs of meetings, studies, research and collaboration are designed to increase awareness of the value and function of credit portfolio management among financial markets worldwide, and to discuss and resolve issues of common interest to its members.