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Moody's Weekly Market Outlook Summary (December 2015)

Core Content

Moody's Weekly Market Outlook for December 2015 highlights the challenges facing US fixed income markets in 2016, particularly due to credit risk and macroeconomic conditions. The publication also provides insights into global economic indicators, credit market trends, and the potential for Federal Reserve rate hikes.

Main Views

• Fed Rate Hikes May Be Halted: The Fed's first rate hike in nearly a decade occurred amid wide credit spreads. If high-yield spreads remain above 650 bp, the Fed may delay future rate hikes, especially if credit conditions worsen.

• Credit Market Correlation: Investment-grade and high-yield bond spreads are highly correlated. The high-yield EDF (Expected Default Frequency) metric is a key driver of both investment-grade and high-yield spreads, indicating a deteriorating credit environment.

• Economic Growth Outlook: The US economy's growth in 2016 is expected to be modest, with GDP growth likely around 2.5%. The "breakout" growth anticipated in earlier forecasts appears to have faded, and the case for aggressive monetary tightening is diminishing.

• Inflation and Wages: Inflation expectations have declined significantly, and wage growth has slowed. This has limited the potential for a strong economic recovery and may constrain the Fed's ability to raise rates.

• High-Yield Market Distress: The high-yield market is experiencing broad-based distress, with spreads remaining elevated and market values dropping. This is not limited to the energy and commodity sectors but extends to other parts of the market.

• Default Rates and Credit Conditions: The US high-yield default rate is projected to rise from 3.0% in November 2015 to 4.1% in November 2016. Credit conditions are expected to remain weak, which could lead to a prolonged credit cycle downturn.

• Global Headwinds: Weak global demand, a strong US dollar, and rising labor costs are putting pressure on corporate profits and margins, limiting the ability of investors to demand lower credit spreads.

Key Information

Credit Spreads

• Investment Grade: Expected to remain near 162 bp by year-end 2016.
• High Yield: Recent spread of 714 bp may drop to 650 bp by year-end 2016.
• Baa and Single-A Spreads: Both show strong correlation with high-yield spreads, indicating a shared credit risk environment.

Defaults

• US HY Default Rate: Projected to rise from 3.0% in November 2015 to 4.1% in November 2016.
• Historical Default Trends: Default rates have declined over time, but the current concentration of low-rated issuers may push the default rate upward during market stress.

Issuance

• US$ IG Bond Offerings: Expected to increase slightly to $1.345 trillion in 2016.
• US$ HY Bond Issuance: Likely to decrease by -7.8% to $328 billion.
• Issuers: The share of global high-yield issuers rated B3 or lower has increased to 57%, up from 21% in 2005.

Fed Policy Outlook

• Rate Hike Expectations: Fed funds futures suggest an average rate of 0.83% in December 2016, below the Fed's projected 1.4%.
• Policy Constraints: The Fed may be too optimistic, and the current economic environment suggests only two rate increases in 2016.

Economic Forecasts

• US GDP: Expected to grow at 1.8% in the third quarter of 2015, but growth is slowing.
• Consumer Spending: Real consumer spending growth fell below 3% in October, indicating a potential slowdown.
• Housing Market: Existing home sales are expected to remain stable, while new home sales may rise in 2016.
• Eurozone: The eurozone is expected to grow at 0.4% in Q4 2015, with a broader recovery anticipated for 2016. However, long-term growth remains sluggish compared to the US.

Market Data Highlights

• Inflation Expectations: Market-derived inflation expectations have dropped to 1.79%, well below the 2.60% average in 2014.
• Consumer Sentiment: Expected to remain stable, with limited improvement in December.
• Producer Price Index (PPI): In France, PPI is forecasted to decline by 2.5% year-on-year in November.

Risk Factors

• Credit Risk: Elevated default rates and weak corporate earnings are likely to keep credit spreads high.
• Global Conditions: Weak demand, commodity price declines, and a strong dollar are pressuring US corporate profits.
• Inflation Outlook: Low inflation expectations and subdued wage growth are limiting the potential for significant rate hikes.

Conclusion

The US fixed income market faces a challenging 2016 due to persistent credit risk, weak economic growth, and subdued inflation. The Fed may be constrained in its rate hiking cycle, and the high-yield market remains under pressure. Global economic conditions and domestic factors such as labor costs and corporate profits will continue to shape credit spreads and the overall market outlook.