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Moody's Weekly Market Outlook Summary (November 2013)

Core Content

This report from Moody's Capital Markets Research provides an outlook for the credit markets and bond issuance in 2014, emphasizing the impact of the Federal Reserve's tapering of quantitative easing (QE) on financial conditions and corporate borrowing.

Main Viewpoints

• Tapering and Market Impact: The Federal Reserve's tapering of QE is expected to raise Treasury bond yields and long-term borrowing costs, potentially disrupting financial markets and slowing domestic spending. However, the US economy's resilience during the government shutdown increased the likelihood of a tapering announcement by March's FOMC meeting.

• Bond Issuance Outlook:

  • Investment Grade (IG): Bond issuance is expected to rise by 1% to $1.147 trillion in 2013, following a record $1.134 trillion in 2012.
  • High Yield (HY): Bond issuance is forecast to increase by 9% to $425 billion in 2013, up from $388 billion in 2012.
  • 2014 Outlook: Moody's anticipates a decline in US corporate bond issuance, potentially by 10%, due to higher yields, reduced refinancing opportunities, and high issuance levels relative to profits and capital spending.

• Credit Spreads:

  • Investment Grade spreads are expected to remain near 108 bp at year-end 2013.
  • High Yield spreads could narrow from 414 bp to 410 bp by year-end 2013 due to improved profit growth.

• Defaults: The US HY default rate is projected to remain around 2.3% to 2.4% for 2014, indicating relatively stable credit quality.

• Mortgage Market:

  • Mortgage yields have risen, slowing home sales.
  • The 10-year Treasury yield increased to 2.8% after the FOMC meeting, signaling market concerns.
  • A 6.0% annual increase in existing home sales in October 2013 was unevenly distributed, with cash-funded sales rising 13% and mortgage-funded sales only 3%, suggesting limited middle-class participation in the housing recovery.

Key Information

• Market Implied Ratings: Moody's ratings for banks are beginning to converge with market-implied ratings derived from CDS and bond spreads, indicating improved alignment between credit ratings and market sentiment.

• Historical Comparison:

  • In 2006, despite a 44 bp rise in speculative-grade bond yields, HY issuance surged by 55% due to above-trend profit growth and increased M&A and capital spending.
  • In 1999, a 68 bp rise in Baa industrial yields limited total debt issuance to a 1% increase, while leveraged loan drawdowns rose 17%.
  • In 1994, a sharp rise in bond yields led to a significant drop in corporate bond issuance, with leveraged loans increasing by 188% due to the unattractive environment for debt refinancing.

• Credit Quality Outlook:

  • The benign outlook for corporate credit quality is expected to support business borrowing.
  • The high-yield default rate is projected to decrease slightly from 2.5% in October 2013 to 2.4% in the next 12 months.
  • The C&I loan delinquency rate for banks reached a record low of 0.97% in Q3-2013, which suggests a stable credit environment and continued access to liquidity.

Ratings and Market Trends

• Moody's Rating Changes:

  • Moody's has made numerous rating changes for global banks, many of which were downgrades due to weakened financial fundamentals, regulatory changes, and governance issues.
  • In June 2012, 15 banks and securities firms were downgraded for their global capital market activities.
  • In March 2013, Moody's began reassessing government support assumptions for US bank holding companies.
  • In August 2013, the senior and subordinated debt ratings of eight major US banks were under review.

• Market Implied Ratings Gaps:

  • The gaps between Moody's ratings and market-implied ratings have been narrowing since the financial crisis.
  • As of November 2013, the gaps for global banks have significantly reduced compared to the levels seen in 2009-2011.
  • The convergence of Moody's ratings and market-implied ratings reflects improved confidence in banks' creditworthiness.

Conclusion

The report highlights the potential challenges for 2014's bond issuance due to the tapering of QE, while also noting the improving credit quality and market sentiment that could support business borrowing. The convergence of Moody's ratings and market-implied ratings for banks suggests a more stable and predictable credit environment, which is a positive sign for the financial sector.