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Moody's Weekly Market Outlook Summary

Core Content

Moody's Weekly Market Outlook highlights the interplay between corporate credit risks, economic activity, and market trends, with a particular focus on the impact of declining sales, M&A activity, and capacity utilization on financial markets.

Main Points

Credit Risks and Sales Performance

• Credit Risks Rise: Business sales are a key indicator of corporate credit quality. Declining sales can lead to increased credit risks.
• Sales Lag Capacity: In Q2-2015, US core business sales rose by 2.2% year-over-year, the weakest performance since Q4-2009, leading to a widening of high-yield bond spreads.
• Industrial Production: Industrial output declined by -1.4% annualized from Q1 to Q2 2015, reflecting weak demand and underutilized capacity.
• Capacity Utilization: The capacity utilization rate fell to 78.4% in Q2-2015, the first year-to-year drop since Q4-2009, signaling a slowing economy.
• Impact on Wages and Inflation: The underutilization of productive resources and energy price deflation are expected to curb US wages, inflation, and profitability.

Relationship Between Credit Markets and Economic Indicators

• Credit Spreads and Capacity Utilization: There is a strong correlation between the year-over-year changes in core business sales and capacity utilization. A 0.91 correlation coefficient indicates a close relationship.
• Treasury Yields and Capacity Utilization: Treasury bond yields tend to move in line with capacity utilization. In 81% of cases where capacity utilization dropped, the 10-year Treasury yield also fell.
• Fed Rate Hikes: The weak performance of core business sales and capacity utilization suggests a cautious approach to future Fed rate hikes. The Fed may avoid aggressive increases due to the anemic recovery.

M&A Activity and Credit Markets

• M&A Frenzy: US M&A activity is at record levels, significantly influencing credit markets. In 2015, M&A linked downgrade reviews accounted for 73% of all US corporate and financial rating reviews, up from 66% in 2014.
• Debt Issuance: M&A activity has driven a surge in USD-denominated bond issuance. As of mid-July 2015, M&A-linked bond issuance reached $217 billion, a 206% increase from the same period in 2014.
• Positive and Negative Impacts: While M&A can lead to credit downgrades due to increased leverage, it can also lead to credit upgrades when acquired by stronger corporate entities. M&A-linked upgrades accounted for 81% of rating reviews in the first two quarters of 2015.
• Debt Valuation: Debt from speculative grade borrowers can gain value if guaranteed by highly rated firms during acquisitions.

Sector-Specific Trends

• Retail Sales: Retail sales in the first half of 2015 grew by 2.0% annually, lagging behind the 3.9% growth in 2014. Auto dealerships were the only category showing strong growth (7.6%).
• Consumer Spending: Weak retail sales may limit consumer spending and hiring activity, further impacting corporate credit quality.
• Energy Sector: Energy price deflation and a significant drop in sales of energy products (-28% annualized) are contributing to the overall slowdown in core business sales.

Key Information

• High-Yield Bond Spreads: The high-yield bond spread widened to 492 bp in Q2-2015, expected to reach 495 bp by year-end 2015.
• US M&A Activity: US M&A volume reached $1.7 trillion in 2015 year-to-date, 25% ahead of 2014's pace.
• Rating Reviews: M&A is a dominant factor in rating reviews, with 73% of downgrade reviews linked to M&A in H1-2015.
• Bond Issuance: M&A-linked bond issuance in 2015 reached $217 billion, surpassing the previous record of $180 billion in 2013.
• Sector Examples: Major M&A deals in the cable and healthcare sectors, such as Charter Communications and CVS Health, highlight ongoing consolidation efforts.

The Week Ahead

• Economic Reports: The report previews upcoming economic data from the US, UK/Europe, and Asia/Pacific regions.
• Market Outlook: Analysts expect continued pressure on credit spreads and bond issuance, with a focus on the impact of M&A and economic conditions.

Long View

• Forecast Charts: Moody's provides charts for key credit market metrics, including core business sales and capacity utilization.
• Historical Trends: Historical data shows that M&A activity has been a major driver of credit rating changes, with notable impacts on bond issuance and market dynamics.

Conclusion

Moody's Weekly Market Outlook underscores the ongoing challenges in corporate credit quality due to weak sales and underutilized capacity. M&A activity remains a significant force in shaping credit markets, with both positive and negative implications. The outlook suggests a cautious approach to Fed rate hikes and continued pressure on high-yield spreads.