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Moody's Weekly Market Outlook Summary

Core Content

Moody's Weekly Market Outlook provides an analysis of credit market trends and economic forecasts for the US, Europe, and Asia-Pacific regions. The report highlights a productivity slump as a key concern for the current economic recovery, which is impacting corporate credit quality and bond spreads. It also includes a detailed preview of upcoming economic data releases and their potential implications on market dynamics.

Main Views

1. Productivity and Credit Quality

• The second quarter of 2016 showed an unsustainable imbalance between US payroll growth (1.8% annually) and real GDP growth (1.2% annually), indicating labor productivity decline.
• Labor productivity fell by -0.4% year-over-year, marking a record low in the five-year average annualized growth rate of 0.6% for a mature business cycle upturn.
• Slow productivity growth can lead to wider credit spreads, especially when unit labor costs grow faster than corporate revenues.
• The median high-yield bond spread narrowed to 553 bp in recent months, which is atypical given the trend in productivity and unit labor costs.

2. High-Yield Bond Spread Analysis

• When corporate gross-value-added fails to outpace unit labor costs by at least 0.5 percentage points, the high-yield bond spread tends to widen.
• The recent narrowing of the high-yield spread suggests potential risks if the trend of unit labor cost growth continues.
• The five-year average of the high-yield bond spread increased from 413 bp to 539 bp as productivity growth slowed.

3. Economic Indicators and Market Outlook

• US Economic Outlook:

  • Retail Sales for July are expected to rise 0.4% overall and 0.1% ex-auto, slightly below June's 0.6%.
  • Producer Price Index (PPI) is forecast to increase 0.1% overall and 0.2% core.
  • Business Inventories are expected to rise 0.1% in June, with firms likely slowing production due to high inventory levels.
  • Consumer Sentiment is expected to rise to 91.5 in August, but may still lag behind pre-2000 levels due to weaker wage growth.
  • Housing Starts & Permits are forecast at 1.18 million and 1.16 million, respectively, indicating positive demand for single-family homes.
  • Consumer Price Index (CPI) is expected to remain stable, with housing costs continuing to rise.

• Europe Economic Outlook:

  • The euro zone's GDP growth is forecast at 0.3% m/m and 1.6% y/y, down from 0.6% m/m and 1.7% y/y.
  • Germany is expected to grow 0.3% in Q2 2016, down from 0.7% in Q1 2016.
  • Italy is projected to grow 0.6% in 2016, but is expected to slow to 0.4% in 2017 due to UK exit concerns.
  • Spain is still the star performer in the euro zone, with GDP growth of 0.7% in Q2 2016.
  • Industrial Production in the euro zone is expected to rise 0.2% m/m and 1% y/y, driven by Germany, Austria, and Italy.

• Asia-Pacific Economic Outlook:

  • Japan's GDP growth for Q2 2016 is expected to be 0.1%, with weak consumption and low wage growth as key drag factors.
  • Thailand's GDP is expected to grow 3.2% y/y, but export weakness and low global demand are limiting growth.
  • Philippines' economy is expanding steadily, but at a slower pace in Q2 2016.
  • India's disinflation trend has abated, with CPI inflation at 5.7% in July and industrial production rising 2.5% y/y in June.
  • China's fixed asset investment is expected to grow 8.8% in July, but overcapacity and currency depreciation are weighing on the outlook.
  • China's industrial production is forecast to rise 6.5% in July, driven by clean energy subsidies and modest electricity output growth.

Key Information

• Credit Spreads:

  • Investment Grade: Expected to remain close to 144 bp year-end 2016.
  • High Yield: May rise to 625 bp year-end 2016, though recent data showed a narrowing to 553 bp.

• Defaults:

  • The US HY default rate is forecast to increase to 6.3% by Q4 2016 from 5.5% in June 2016.

• Bond Issuance:

  • US$-denominated investment-grade (IG) bond issuance is expected to rise 8.8% to a record $1.443 trillion in 2016.
  • US$-denominated high-yield (HY) bond issuance is projected to fall -9.9% to $319 billion.

• Ratings Round-Up:

  • The report notes a mixed message from credit market indicators, suggesting uncertainty in the current economic environment.

• Market Data:

  • The report includes updates on credit spreads, CDS movers, and bond issuance trends.

• Important Figures:

  • Figure 1: Labor productivity's five-year average annualized growth rate reached a record low of 0.6% in Q2 2016.
  • Figure 2: High-yield bond spread narrowing suggests slower unit labor cost growth and faster corporate gross-value-added growth.
  • Figure 3: A recession is near when unit labor costs outpace corporate gross-value-added growth over a year-long span.
  • Figure 4: High-yield bond spread is 403 bp when core revenue growth exceeds 4.0%, and 670 bp when it falls below.

Conclusion

The report underscores the challenges facing the current economic recovery, particularly in the US and Europe, where productivity and wage growth are underperforming. In Asia-Pacific, China and India show mixed signals, with China showing some positive momentum and India continuing to face disinflation and overcapacity issues. The high-yield bond spread is narrowing, but this may be misleading due to the trend in unit labor costs. The FOMC meeting minutes and Leading Economic Index are key indicators to watch for potential economic shifts in the coming weeks.