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Moody's 2016 Weekly Market Outlook Summary

Core Content

This document provides a comprehensive review and outlook for credit markets in the wake of the 2016 US presidential election, highlighting the potential impacts of tax cuts, regulatory changes, and global economic conditions on corporate credit quality, bond spreads, and default rates.

Main Points

1. Credit Market Outlook for 2017

• Profit Outlook: The potential for higher profits in 2017 is expected due to corporate tax cuts and reduced regulation. However, this is offset by higher interest rates and a stronger US dollar.
• Mortgage Yields: Higher mortgage yields are likely to dampen home sales, as seen in the slowdown of the pending home sales index.
• Corporate Credit Quality: While there is some improvement in corporate credit quality, the overall outlook remains cautious. The default rate for US high yield bonds is expected to decrease slightly but remain above historical averages.

2. Bond Spreads and Default Rates

• Credit Spreads:
  • Investment Grade: Expected to remain close to 121 bp by year-end 2016.
  • High Yield: Projected to rise from 448 bp to 525 bp by year-end 2017.
• Default Rate:
  • US HY default rate is expected to fall from 5.6% in November 2016 to 3.9% by 2H 2017, though it will still be above the 1.85% average of 2015.
• Equity Rally and Defaults: The post-election equity rally has improved financial conditions for low-grade corporate credits, potentially reducing high-yield defaults. However, the VIX index and EDF metric show differing views on the spread, with EDF suggesting a higher spread than VIX.

3. Economic and Fiscal Outlook

• Infrastructure Spending: Despite the potential for fiscal stimulus, infrastructure spending is expected to be constrained due to high government debt and political hurdles.
• Federal Debt: US government debt is already at 76% of GDP, significantly higher than the 42% of GDP in the early 1990s. It is unlikely to reach the 100% level seen during WWII.
• Aging Population: The aging population and its funding needs may limit the impact of fiscal stimulus on economic growth.

4. Global Economic Growth and Sector Outlook

• GDP Forecast: The Blue Chip consensus forecasts 2.2% growth for 2017, showing little improvement post-election, suggesting that the economic recovery is not robust.
• Sector Performance:
  • Positive Outlook: Aerospace and Defense, Building Materials, Consumer Durables, etc.
  • Negative Outlook: Automotive Manufacturers, Manufacturing (North America), Newspapers & Magazines (US), etc.
• Commodity Prices: A rebound in commodity prices has improved credit conditions for some sectors, especially energy and industrial metals, but not all.

5. M&A and Rating Reviews

• M&A Impact: M&A activity is a significant driver of rating review actions, with 68% of downgrade reviews and 57% of upgrade reviews linked to M&A in the current quarter.
• Rating Changes: There has been a limited number of rating upgrades and downgrades, with the majority of rating reviews stemming from M&A and shareholder payments.

Key Information

6. Market Data and Trends

• Bond Issuance:
  • US$-denominated investment grade bond issuance is expected to reach a record $1.418 trillion in 2016, while high yield bond issuance is projected to fall by 4.6% to $337 billion.
• Credit Policy Group: Forecasts that the default rate for US high yield bonds will stabilize around 3.9% in 2H 2017.
• Funding Constraints: Corporate cash held abroad is concentrated among a few investment-grade companies, limiting the impact of repatriation on capital expenditures.

7. Conclusion

• The credit markets are expected to remain cautiously optimistic in 2017, with the potential for modest improvements in corporate credit quality and bond spreads.
• However, the overall economic recovery is weak, and factors such as a stronger dollar, higher interest rates, and constrained fiscal stimulus may limit the positive impact of tax cuts and regulatory changes.
• The aging population and its funding needs are expected to continue to put pressure on the federal budget and limit the effectiveness of any fiscal stimulus.