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Moody's Weekly Market Outlook Summary

Core Content

This report from Moody's Analytics provides an in-depth analysis of the current state and future outlook of credit markets, focusing on corporate debt trends, economic indicators, and investment strategies. The report highlights the relationship between corporate debt levels, economic growth, and interest rates, while also touching on the performance of gold as an investment option amid low yields and weak growth.

Main Views

1. Corporate Debt Trends

• Corporate debt growth outpaces GDP: Since June 2011, nonfinancial-corporate debt has grown at a faster rate than nominal GDP, with an annualized increase of 6.6% compared to 3.6% for GDP.
• High debt-to-revenue ratio: The ratio of corporate debt to net revenues has risen to 93.0% in Q2-2016, the highest since the Great Recession, despite weak net revenue growth.
• High-yield bond spreads: The high-yield bond spread has not followed the typical pattern of widening with higher debt-to-revenue ratios, possibly due to ultra-low interest rates and expectations of economic recovery.

2. Credit Market Risks and Opportunities

• Interest rate risk: While the risk of rising interest rates is a concern, current low inflation expectations and compressed yield curves suggest that potential losses from rate hikes may be limited.
• Credit risk and yield trade-off: Moderate credit risk can provide higher yields, such as Baa-rated corporate debt with a 3.28% yield versus 1.18% for Treasuries. The high-yield market (Ba-rated) offers 4.81% yield with a historical default rate of 0.92%.
• Debt sustainability concerns: The report raises concerns about corporate debt sustainability, especially with the rise in defaults and weak investment spending, but notes that borrowing costs have adjusted accordingly.

3. Gold as an Investment

• Gold as a safe haven: Prominent investment managers are shifting towards gold due to weak growth, low inflation, and low bond yields.
• Gold's performance: Gold prices have shown a strong year-over-year increase of 25%, but have historically been more influenced by speculative money flows than economic fundamentals.
• Gold ETFs and demand: ETF holdings of gold have closely tracked prices with a high correlation (0.98), and demand for gold bars, coins, and ETFs has increased significantly.

Key Economic Indicators

1. GDP and Net Revenues

• Nominal GDP growth: Annualized growth has averaged 3.6% since 2011, with a weaker 1.2% growth in Q2-2016.
• Nonfinancial-corporate gross-value-added: Shows a strong correlation (0.85) with nominal GDP and has grown at a similar pace.
• Real GDP growth: Slowed to 1.2% in Q2-2016, the lowest since Q2-2013, suggesting potential for wider credit spreads.

2. Credit Spreads

• Investment Grade: Expected to remain close to 146 bp at year-end 2016.
• High Yield: May approach 630 bp by year-end 2016, wider than the recent 584 bp.

3. Default Rates

• US HY default rate: Forecast to rise to 6.4% by Q4-2016, up from 5.1% in June 2016.

The Week Ahead

US Reports

• Employment Report - July: Forecast to show 180,000 nonfarm payrolls and a 4.8% unemployment rate.
• Trade Balance – June: Expected to widen to -$43.0 billion.
• Productivity & Unit Labor Costs - Second Quarter Preliminary: Projected to rise 0.6% and 1.6% respectively.
• Import Price Index - July: Expected to fall by -0.3%.
• Retail Sales - July: Projected to rise 0.2% overall and 0.2% ex auto.
• Producer Price Index - July: Expected to rise 0.1% overall and 0.2% core.
• Business Inventories – June: Forecast to increase by 0.2%.
• University of Michigan Consumer Sentiment - August Preliminary: Expected to rise to 92.0.

Europe Reports

• Germany: Industrial Production (June): Likely to fall 0.2% m/m, with the ZEW indicator dropping to -6.8.
• Spain: Industrial Production (June): Expected to grow 1.5% y/y, with a rise in industrial confidence.
• Italy: Economic Growth: Projected to slow to 0.1% m/m, amid political and banking sector uncertainties.
• France: Industrial Production: Expected to increase 0.3% m/m, offsetting weak household consumption.

The Long View

• Credit Market Metrics: The report includes a chart showing the correlation between credit spreads and economic indicators.
• Historical Context: The current debt-to-revenue ratio is the highest since the Great Recession, but the low net interest expense due to ultra-low interest rates has mitigated debt servicing risks.
• Future Outlook: If real GDP growth remains sluggish, high-yield spreads may widen, and benchmark interest rates may not rise until growth accelerates to at least 4%.

Conclusion

The report emphasizes the current imbalance in corporate debt relative to net revenues, the potential for rising interest rates to impact credit markets, and the shift in investor sentiment towards gold and moderate credit risk. It also outlines key economic data points and forecasts for the upcoming week in the US, Europe, and Asia-Pacific, suggesting that while the economy is showing signs of recovery, risks remain due to weak growth and inflation expectations.