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Moody's Weekly Market Outlook Summary

Core Content

Moody's Weekly Market Outlook provides insights into credit markets, economic indicators, and market data for the US, UK/Europe, and Asia-Pacific regions. The report is authored by John Lonski, Njundu Sanneh, and Franklin Kim, with additional contributions from Yuki Choi and regional analysts. Key themes include the behavior of credit spreads, default risk, and the impact of macroeconomic indicators on financial markets.

Main Views

1. Credit Market Outlook

• Credit Spreads: The report highlights the potential for widening low-grade (high-yield) bond spreads, with forecasts suggesting they may reach 450 bp by year-end 2017.

  • As of August 9, high-yield bond spreads were at 387 bp, up from 371 bp on August 8.
  • The VIX index, which had previously supported thin spreads, surged to 15.2, signaling increased market uncertainty and potentially leading to spread widening.
  • Models based on EDF (Expected Default Frequency) metrics suggest the high-yield bond spread could be between 443 bp and 517 bp by year-end 2017.

• Defaults: Moody's Credit Policy Group forecasts the US trailing 12-month high-yield default rate to average 2.9% during the second quarter of 2018, down from 3.8% in June 2017.

  • The high-yield EDF metric is more sensitive to base metals price movements than the bond spread itself.

• Issuance Trends:

  • US$-denominated investment-grade (IG) bond issuance reached a record $1.506 trillion in 2017, up 6.7% from 2016.
  • High-yield bond issuance increased by 23.1% in 2017 to $430 billion, still below the 2014 peak of $435 billion.

2. Base Metals Price Index

• The Moody's Industrial Metals Price Index hit a three-year high on August 9, 2017, indicating a material expansion in global industrial activity.
• The index shows a strong correlation with world economic growth (0.81 since 1989), suggesting continued growth momentum.
• Base metals price inflation tends to narrow high-yield spreads, while deflation may cause spreads to widen.

3. Macroeconomic Correlations

• Base metals prices have a stronger inverse correlation with default risk than oil prices.
• Oil price inflation is linked to broader inflationary pressures, particularly through its impact on the PCE (Personal Consumption Expenditures) price index.
• Core PCE inflation is more stable than overall PCE inflation and is less influenced by energy price fluctuations.

Key Economic Indicators

The Week Ahead – US, Europe, Asia-Pacific

The US

• Jobless Claims: Forecast at 242,000 for the week ending August 5.
• Consumer Price Index (CPI): Expected to rise 0.2% in July for both headline and core CPI.
  • Core CPI is expected to show a trend-like increase in rents.
  • Medical prices, particularly physician services, are under close watch after a significant deceleration in growth.
• Fed Policy: The Fed is expected to announce plans to reduce its balance sheet in September. A rate hike in December is likely unless inflation or labor market data show signs of weakness.

Europe

• Industrial Production: Expected to contract slightly in the UK and France, with France's industrial production likely falling 0.6% m/m in June, while Germany's inflation accelerated to 1.7% y/y in July.
• Eurozone Growth: The report suggests the eurozone has transitioned to a steady growth path rather than a recovery.
• Inflation Trends: Eurozone inflation is expected to remain stable, with core goods inflation picking up due to stronger economic momentum.

Asia-Pacific

• China: July data are expected to show positive growth, driven by tech manufacturing and increased demand for electronics.
• Philippines: Industrial production growth is forecast to remain at 5.8% y/y in June, supported by both domestic and international demand.
• Japan: Machinery orders are expected to rise 1.1% in June, signaling a recovery in export-oriented manufacturing.
• Malaysia: Industrial production growth is forecast at 4.4% y/y in June, driven by electronics demand linked to the global tech cycle.

Conclusion

The report underscores the interplay between macroeconomic indicators, credit spreads, and default risk. It highlights the potential for high-yield spreads to widen due to rising uncertainty and the VIX index, while noting that base metals price inflation may provide some support to credit markets. The US, Europe, and Asia-Pacific regions show mixed signals, with the eurozone appearing to stabilize and the US and China showing continued growth momentum. The Fed's policy trajectory remains closely tied to inflation and labor market data, with the potential for another rate hike in December 2017 if conditions remain stable.